<PAGE>

                                                      Exhibit 13
January 26, 1998



1997--A RECORD BREAKING YEAR

Fiscal 1997 was quite simply the best year in Chattem's 119 year
history. Sales increased 20% to $143 million and earnings per
share from continuing operations jumped 70% to $.80 per share.

At Chattem, we continually talk of the importance of maintaining
momentum. This year's 70% increase in EPS, on top of last year's
47% increase, establishes this period as an all time record
breaking one. Our goal for 1998 is to keep this momentum
going strongly as we head towards $200 million in sales.


1997 HIGHLIGHTS

For the second consecutive year, GOLD BOND was the number one
reason for our strong results. GOLD BOND Medicated Powder
maintained its dominance of the adult powder market. GOLD BOND
Cream continued to grow and gain market share in the anti-itch
cream category. Finally, our two new products, GOLD BOND Foot
Powder and GOLD BOND Cornstarch Plus Baby Powder, were both
successfully introduced.

A second notable highlight was the continued strong growth of ICY
HOT. ICY HOT has been on a growth track ever since its
acquisition in 1991, but fiscal 1997 was the best year ever for
ICY HOT, with sales increasing over 35%, led by the introduction
of ICY HOT Arthritis Therapy Gel.


<PAGE>

The SUNSOURCE acquisition including the brands GARLIQUE, REJUVEX,
MELATONEX, PROPALMEX and ECHINEX was another driving factor
behind 1997 results. The SUNSOURCE acquisition not only brought
us five important herbal brands, but more importantly positioned
us as a leader in the dramatically growing herbal market. 
Through five months, SUNSOURCE performed on plan with very strong
results from GARLIQUE offsetting lower results from ECHINEX.


In addition to the above highlights, we had another very good
year in terms of controlling expenses leading to improved
profitability. Areas of focus were improving profitability on
our toiletries brands, controlling people expenses and reducing
overall general and administrative expenses. These efforts
resulted in a record operating income of almost 17.8% of sales
versus 14% last year. Selling, general and administrative
expenses declined from 18.2% to 15.6% of sales.

These results were achieved while we continued to invest in
advertising and promotion to drive our brands' growth. For the
year, advertising and promotion expenses increased 23.4% to 39.2%
of sales, versus 38.3% last year.

On the negative side, we had a few brands that didn't meet our 
expectations. BULLFROG was down about 16%, reflecting a couple of 
key accounts which did not run expected programs. In 1998,  
BULLFROG sales should jump dramatically, as we have several major 
accounts committed to strong programs.  

PHISODERM and FLEXALL also failed to meet expectations. We are
planning major new creative and media support to rejuvenate these
two brands.

1998--THE YEAR OF NEW PRODUCTS

As we look to continue our momentum into 1998, two extremely
exciting new products will be major factors. The first which
began shipping February 15 is HARMONEX. When we acquired
SUNSOURCE last year, a major reason for the acquisition was that
it provided a platform to introduce new herbal products, and we
believe HARMONEX is potentially one of SUNSOURCE'S biggest
opportunities ever.


<PAGE>

HARMONEX is a combination of St. John's Wort, proven to help
emotional balance, with Siberian Ginseng, an herb providing a
boost to our physical well being. This product harkens back to
the Roman concept of a sound mind and a sound body.

The market for such a product is huge, as almost half of American
adults suffer some combination of mild depression, low spirits,
chronic anxiety or severe mood swings. Also, it is a widely held
belief that continued anxiety, stress or low spirits can lead to
physical health problems. 

Dr. Harold Bloomfield is perhaps America's number one expert on
anxiety and depression and author of the best seller, HYPERCIUM
AND DEPRESSION (Hypercium is the active ingredient in St. John's
Wort) and the upcoming book, HEALING ANXIETY WITH HERBS. His
books are full of exciting material for people more interested in
the power of herbs to provide emotional and physical well being.
Dr. Bloomfield is a proponent of the HARMONEX formula and will
work with us as a consultant for the next year.

Given the exciting opportunity for HARMONEX, we will be spending
more advertising dollars on this launch than any other in our
history. For the six months starting May 1, we will be spending
at a reported annual rate of $15- $20 million.

Our other major launch is a GOLD BOND extension in the second
half of the year. This new product will extend the strong GOLD
BOND franchise into its largest category ever. This line
extension is the most researched new product in our history. We
will be launching it with annual media spending of approximately
$15 million, plus the distribution of 4 million samples.

We have targeted to invest amounts equal to $.20 to $.25 per
share to support these two launches for 1998.

CONTINUED BRAND DEVELOPMENT 

Over the last several years, we have invested in advertising and
promotions to grow our brands. We will continue this in 1998
with several strong and innovative programs, which I will briefly
highlight.


<PAGE>

ICY HOT will receive another record year of advertising support
behind both the growing base franchise, plus new ARTHRITIS
THERAPY GEL, which in January, 1998 had its best Nielsen ever.
BULLFROG should achieve its highest sales volume in history, due 
to several major accounts making strong commitments to BULLFROG.
BULLFROG will be supported by record media spending on national 
radio starting with Spring Break.

Several brands will receive new advertising programs for 1998.
FLEXALL will receive significant new creative as well as radio
support. CORN SILK will have its largest print campaign starting
in January. For SUNSOURCE, all the brands will have major
advertising support.  At this point, GARLIQUE appears to be
responding the most dramatically, although REJUVEX and PROPALMEX
are doing well.

CONCLUSIONS

Finally, 1998 started with a significant management change at
Chattem. Bob Bosworth, Executive Vice-President and Chief
Financial Officer, left us after an outstanding eighteen year
record at Chattem. He will remain on our Board.

Fortunately, Alec Taylor, a Board member for four years as well
as our legal counsel for eight years, joined us as President and
Chief Operating Officer. In addition to the fact that no one
worked closer with Bob than Alec, he brings outstanding
managerial skills to us.

Someone asked me how I felt about this, and I replied that "It is
like having Joe Montana retire but Steve Young sitting on the
bench."  

Our profit plan for 1998 shows that we should be able to continue
our growth with sales forecasted up 20% and earnings per share up
15-20% after investing $.20-$.25 per share in new product
launches. I hope I can again next year have another superior
story to report to you.

<PAGE>

DOMESTIC PRODUCT OVERVIEW
OTC Pharmaceuticals - Topical Analgesics

The Company competes in the topical analgesic category, a $217 million market,
with its FLEXALL and ICY HOT brands.  BENZODENT competes in the $62 million
internal irritation segment of the topical oral analgesic category.

Overall, Chattem's position in the topical analgesic market improved by over one
share point during 1997.  FLEXALL, an aloe-based topical analgesic clinically
proven to provide long lasting relief for arthritis and other muscle and joint
pain, became the number two brand in the category.  The brand's current product
line includes Original Vitamin E Enriched and Maximum Strength FLEXALL, which
contain menthol, as well as Ultra Plus which contains three active ingredients:
menthol, methyl salicylate and camphor.

With its sixth consecutive year of sales growth in 1997, ICY HOT moved up to the
number four position in the category.  The brand's double digit growth was the
result of new packaging, increased marketing support, new unique television
commercials as well as the launch of Arthritis Therapy Gel which contains the
active ingredient doctor's recommend most: capsaicin.  ICY HOT offers the most
complete product form line-up in the category with a cream, a balm and the
unique chill stick.  Further, consumer research continues to indicate that the
brand's distinctive Icy and Hot Therapy for Pain positioning enjoys high
awareness and is viewed as the most compelling in the category.

BENZODENT, a topical oral analgesic, is the only brand positioned to be applied
directly to dentures to relieve the pain.  The product contains the maximum
amount of benzocaine allowable in the category and is widely recommended by
dentists.  Marketing efforts are focused on providing samples to consumers when
they are initially fitted for dentures, the point of entry for the category.



                                       1
<PAGE>

OTC Pharmaceuticals -
Medicated Powder and Cream

The Company competes in the medicated powder ($80 million) and cream ($170
million) markets with its GOLD BOND Medicated Powder and GOLD BOND Medicated
Cream.  GOLD BOND is America's number one medicated powder brand as well as one
of the fastest growing brands in the anti-itch cream segment.  During 1997, GOLD
BOND successfully launched two new products: GOLD BOND Foot Powder and GOLD BOND
CORNSTARCH PLUS Medicated Baby Powder.  In addition to these two products, the
GOLD BOND line includes GOLD BOND Medicated Powder, GOLD BOND Extra Strength
Medicated Powder, GOLD BOND Medicated Baby Powder and GOLD BOND Medicated Cream.
Looking to 1998, the brand has plans to further expand the franchise with a
major line extension.  For the year, the brand will benefit from record levels
of advertising and promotional support.



OTC Pharmaceuticals - Internal Analgesics

The Company competes in the $60 million menstrual pain relief category with its
PAMPRIN and PREMSYN PMS brands.  NORWICH aspirin competes in the general
analgesics category.  

PAMPRIN, the number two brand in the menstrual analgesics category, is a
combination drug specifically designed for relief of menstrual symptoms. 
Multi-symptom PAMPRIN effectively relieves multiple menstrual discomforts with
three active ingredients.  Maximum Pain Relief PAMPRIN  is formulated to provide
superior cramp relief and is the only cramp relief product with two pain
relievers.  Maximum Strength PREMSYN PMS, the third largest brand in the
category, effectively relieves the physical and emotional symptoms of PMS.  


NORWICH, a high-quality, reasonably priced aspirin, complements the other OTC
pharmaceuticals of the division.  The brand is principally focused in sales and
marketing support in the northeast, midwest and west coast.



                                          2

<PAGE>
OTC Pharmaceuticals - Lip Care

The Company competes in the $210 million lip care category with the HERPECIN-L
brand.  1998 includes two major HERPECIN-L initiatives.  In January, a
reformulated HERPECIN-L stick was launched.  This stick offers a new skin
protectant and a significantly higher SPF.  Consumer testing indicates a strong
preference for the new formulation by both loyal HERPECIN-L consumers as well as
general category users.  In addition, HERPECIN-L jar began shipping in February.
The new jar product promotes cold sore healing, is a moisturizer and protects
lips from the harmful rays of the sun with a SPF of 30 in a form that is 
extremely popular within the lip care category.  These two initiatives will
receive national television advertising and promotional support.


Toiletries & Cosmetics - Face Makeup

The Company competes in the oil control face makeup segment which is an $83
million niche within the overall cosmetics category with its CORNSILK brand. 
CORNSILK, the number three brand in the oil control makeup segment, is the
original face makeup line specially formulated to absorb excess facial oil. 
These formula properties guarantee users a long-lasting, shineless makeup
finish.  The CORNSILK product line includes loose and pressed powders in two
finishes and four shade variations; liquid makeup in six shades; a cream
concealer and an enriched coverstick concealer.  In 1997, CORNSILK introduced a
contemporary new blue package which was successfully transitioned at retail.  In
1998, to benefit from important new makeup trends, CORNSILK will be adding a six
shade line of light liquid makeup under the sub-brand Weightless.  Also in 1998,
CORNSILK will build on its successful yellow enriched coverstick launch with the
addition of a green enriched coverstick.  CORNSILK is supported with an
extensive print campaign in women's magazines touting the long-lasting and
natural looking brand benefits.


Toiletries & Cosmetics - Skincare

Within the skincare category, the Company competes in the $428 million facial
cleanser category with its PHISODERM brand and in the $20 million face masque
sub-segment with MUDD Spa Treatment masque products.



                                          3

<PAGE>

PHISODERM is a specialty facial cleanser positioned as the daily prescription
for healthy skin.  The dermatologist developed, pH balanced formulas are
available in four different varieties: Normal to Dry, Normal to Oily, Sensitive
Skin and for Baby.  Every PHISODERM product delivers superior cleansing without
the harsh drying effects of soap.  In 1997, PHISODERM introduced a bold, green,
ethical new label design.  This bolstered the therapeutic image of the brand as
well as its tie to dermatology.  Also in 1997, PHISODERM was prominently
featured in an extensive print advertising campaign.  In 1998, PHISODERM will
claim leading share of voice advertising for facial cleansers on radio.  The
radio campaign will build on the idea of being the daily prescription for
healthy skin with strong consumer testimonials.

PHISODERM is also represented with a two size product offering in the $212
million antibacterial hand cleanser category.  This product launched in 1996,
extends brand recognition into a complementary category to facial cleansing. 
PHISODERM Antibacterial Hand Cleanser is primarily sold through a broker sales
force established to provide national retail coverage for the food class of
trade.

The MUDD brand continues to show strong retail growth stemming from the relaunch
of MUDD Original Masque under the Spa Treatment banner and the introduction of
Sea Masque and Aloe Masque which are all top 10 selling masque items.  These
products were joined in 1997 by MUDD 5 Minute Masque which revolutionized the
category by providing all of the deep cleansing benefits of a clay-based masque
product but in one third of the time.


Toiletries & Cosmetics - Seasonal

The Company competes in three seasonal product categories:  SPF 15 + suncare, 
spray-on hair lightener and chlorine removal haircare and skincare. In the 
suncare category, the Company competes with products that have a sun 
protection factor (SPF) of greater than 15, a $270 million category, with its 
BULLFROG Sunblock line.  SUN-IN competes in the $9 million spray-on hair 
lightener category, while ULTRASWIM  Shampoo, Conditioner, Soap and Shower 
Gel strongly dominate the small chlorine removal category.

                                          4

<PAGE>

Over the past several years BULLFROG Sunblock has been one of the fastest 
growing brands in the category.  BULLFROG Sunblock products are available in 
ten unique gels and lotions and provide all day protection in or out of the 
water. BULLFROG is positioned as the Ultimate Waterproof Sunblock and is the 
essential sun protection product for an outdoor active lifestyle.  In 1997, 
BULLFROG Quick Gel SPF 36 was added to the line providing higher protection 
in its revolutionary quick-applying formula.  BULLFROG awareness was driven 
in 1997 by strong levels of regional, seasonal television advertising.  
Dramatic growth is forecast for BULLFROG in 1998.  During 1998, two products 
will be added with the introduction of BULLFROG for Babies and SUPERBLOCK 
SPF45.  In 1998, BULLFROG will have additional advertising support with new 
Spring Break radio advertising and strong levels of national radio 
advertising during an expanded Summer schedule.

SUN-IN, which is available in three formulas, (Super, Super with Lemon and 
for Men), enjoyed a renewed interest by consumers in the spray-on category and 
a return to brand growth.  In 1997, SUN-IN was supported by regional, 
seasonal television advertising and earlier display distribution which drove 
consumer awareness during Spring Break.  In 1998, SUN-IN will introduce 
bright, contemporary new packaging and a formula enhancement with the 
addition of illuminators for healthy shine.  A public relations campaign to 
teen magazines will play a significant role in driving brand awareness for 
SUN-IN in 1998.

ULTRASWIM has maintained its leadership position as the standard product for
chlorine removal.  The ULTRASWIM product line includes shampoo, conditioner,
soap and shower gel.  In 1997, ULTRASWIM utilized targeted print advertising
featuring our spokesperson Olympic Swimmer Janet Evans to communicate to target
consumers: competitive swimmers, fitness swimmers and recreational swimmers. 
In 1998, ULTRASWIM Shampoo and Conditioner will be introduced in an improved
bottle with formula enhancements.  The shampoo product will be repositioned as
ULTRASWIM Shampoo Plus and the conditioner will be repositioned as ULTRASWIM
Ultra Repair Conditioner.  Targeted advertising for ULTRASWIM with a product
focused message will continue in 1998.



                                          5

<PAGE>

Dietary Supplements

The Company competes in the $6.5 billion U.S. vitamin/mineral marketplace with
its products REJUVEX, GARLIQUE, PROPALMEX, ECHINEX, HARMONEX, MELATONEX and
SUNSOURCE Traditional Homeopathic medicines.  These products are distributed
primarily through mass trade channels consisting of food, drug and discount
stores.  In 1997, mass trade vitamin/mineral sales totaled $2.6 billion, up 25%
from the previous year, while the category of nutritional supplements generated
an unprecedented $918 million in sales, up 48% from the same period.  In the
past year, sales of herbal products have risen an average of 56% in food, drug
and discount stores and have reached $339 million.

REJUVEX, introduced in 1991, is the oldest SUNSOURCE brand and the number one 
selling product in the women's supplement category.  REJUVEX is uniquely 
positioned to support menopausal comfort and healthy bones for women in the 
peri- and post-menopausal age group.  A winner of the prestigious Rex award 
in 1995 for best nutritional supplement in the chain drug industry, REJUVEX 
is a unique natural formula containing a combination of magnesium, vitamins, 
antioxidants and other important nutrients, which helps meet the changing 
nutritional needs of women.

The Company competes in the herbal category with its GARLIQUE, PROPALMEX and 
ECHINEX brands.  Introduced in 1993, GARLIQUE now owns a 12% share of the $75 
million garlic category, and is presently its number one selling product.  
Backed by extensive clinical research on the benefits of garlic, GARLIQUE is 
positioned for its positive benefits in support of cardiovascular health.  In 
recent years scientists have identified allicin as the active ingredient in 
garlic. GARLIQUE'S unique production process insures the maximum amount of 
allicin in each tablet, and is further positioned as the world leader in 
product potency.  GARLIQUE is rapidly ascending to the pinnacle of the herbal 
category, aided by spokesperson Larry King.

PROPALMEX, the top selling brand in the $18 million saw palmetto herbal 
category, owns a 23% market share, and is positioned to support health and 
free urinary flow for men over 40.  As men age, natural changes in hormone 
balance result in conditions which tend to precipitate a swelling of the 
prostate gland. This benign condition plaques most men past middle age.  
PROPALMEX contains clinically tested, standardized saw palmetto, and is the 
all-natural, drug-free approach to maintenance of a healthy prostate.  
PROPALMEX was introduced to the mass trade consumer in 1996.  

                                          6

<PAGE>

ECHINEX, the last of three herbal products introduced by SUNSOURCE in 1996, is a
standardized herbal complex of echinacea, ginger and Siberian ginseng.  This
unique and effective combination is positioned to support natural resistance
against infection.  ECHINEX is a seasonal product that provides added protection
during times of high risk for colds and flu.  It presently holds a 3.7% of the
$43 million echinacea category.  

In May 1998, SUNSOURCE will introduce its newest herbal product, HARMONEX. 
HARMONEX contains a unique combination of St. John's Wort for emotional
well-being and Siberian ginseng for physical well-being.  HARMONEX enters the
fast growing St. John's Wort category, up 1,137% through the first three
quarters of 1997, and now selling at an annual rate of $100 million in sales. 
The HARMONEX new product launch will be the largest ever by SUNSOURCE or
Chattem.  In addition to unprecedented consumer advertising levels planned for
its promotion, HARMONEX will also be supported by a powerful public relations
campaign.

The Company competes and is a leader in the $48 million melatonin category 
with MELATONEX.  MELATONEX, the third largest melatonin brand, is positioned 
to support a natural sleep cycle and owns a 13% share of the category.  The 
product uses a unique time-release delivery system, releasing melatonin as 
the body does, gradually, while you sleep.  MELATONEX contains the finest 
pure melatonin (not of animal origin) made in accordance with strict quality 
control requirements.  Melatonin sold under the MELATONEX name is tested 
regularly by independent laboratories to meet SUNSOURCE'S rigorous quality 
control requirements.

The Company also competes in the homeopathic category with its line of SUNSOURCE
traditional homeopathic medicines.  Sales of homeopathic products through mass
trade channels total $29 million, up 29% from the previous year.



                                          7

<PAGE>

SUNSOURCE owns a 10% share of the category.  The line, based on the principles
of homeopathy, was introduced by SUNSOURCE in 1994.  Homeopathic medicine was
developed by Dr. Samuel Hahnemann (1755-1843), who based his medicine on the law
of similars which states a substance which caused symptoms of an illness when
given in large dose to a healthy person will help to aid the healing when given
in a small dose to a sick person.  The nine products in the line include six
tablet products:  Sinus relief, Allergy relief, Cold relief, Flu relief,
Arthritis relief, Insomnia relief and three cream products: Sports Injury
Cream, Arthritis Relief Cream, and Psoriasis Eczema Relief Cream.  All SUNSOURCE
homeopathic medicines are manufactured using state of the art production,
insuring optimum quality and effectiveness.  SUNSOURCE Traditional Homeopathic
Medicines are the top selling homeopathic line of products in food, drug and
discount stores.

The Company plans to continue the expansion of the SUNSOURCE line of products,
and is presently in the process of evaluating new product opportunities to be
introduced in the future.


INTERNATIONAL MARKET OVERVIEW
Canada

Chattem (Canada) Inc. is a wholly-owned subsidiary based in Mississauga, Ontario
which markets and distributes Chattem's consumer products throughout Canada. 
The manufacturing of the brands is principally done in the Company's facilities
in Chattanooga while some packaging takes place in Mississauga.  The division
utilizes a national broker for its sales efforts.  Brands marketed and sold in
Canada include GOLD BOND, PAMPRIN, FLEX-ALL, CORNSILK, MUDD, SUN-IN, BULLFROG,
ULTRASWIM and PHISODERM.  In addition, Chattem owns the marketing and
distribution rights for SHY, a line of feminine hygiene and douche products;
ACNOMEL, a medicated acne mask; as well as AQUA CARE and ROSE MILK.



                                          8

<PAGE>

Europe

Chattem's European business is conducted through Chattem (U.K.) Limited, a
wholly-owned subsidiary located in Basingstoke, Hampshire, England.  This unit
also services distributors in Australia and the Middle East.  Manufacturing and
packaging of the products is performed principally in the U.K. with a limited
number of ingredients purchased from Chattem.  Chattem (U.K.), the division
employs its own sales force while exclusive distributors are used to market and
sell its products on the Western European Continent.  Due to the difficulty and
expense involved in the registration of OTC pharmaceuticals in Europe, the unit
markets exclusively the Company's toiletry products.  Chattem's products in
Europe include SUN-IN, a range of MUDD Face and Body products, ULTRASWIM and
CORNSILK.  SPRAY BLOND Spray-In Hair Lightener is only marketed on the
continent.


U.S. Export

The U.S. Export division services various distributors primarily located in the
Caribbean, Mexico and Peru.  The Company sells ICY HOT, GOLD BOND, PAMPRIN, MUDD
and PHISODERM into these markets with the primary focus being the development of
its OTC pharmaceuticals.  The Company continues to look for established
distributors in Central and South America.



                                          9


<PAGE>

Management's Discussion and Analysis of Financial Condition and Results of
Operations
--------------------------------------------------------------------------

GENERAL

On June 26, 1997, the Company purchased certain assets of Sunsource 
International, Inc. and an affiliated company ("SUNSOURCE") including the 
exclusive worldwide rights to five leading branded dietary supplement 
products. The purchase price of the trademarks, inventory and receivables was 
approximately $32,000,000. Additional payments may be earned by SUNSOURCE 
over a six year period from the date of closing if sales, net of certain 
assumed liabilities, exceed certain levels as defined in the purchase 
agreement, but such additional payments are not to exceed $15,750,000 in the 
aggregate. Financing of the SUNSOURCE acquisition was provided by an 
expansion of the Company's senior bank credit agreement and the issuance of 
300,000 shares of Chattem common stock to SUNSOURCE.

The Company expanded its existing credit agreement with a syndicate of banks 
on June 26, 1997 to finance the SUNSOURCE acquisition and repay all existing 
bank debt. The credit agreement is divided into a $30,000,000 revolving line 
of credit for working capital purposes, a 5 year $30,000,000 Term A loan 
facility and a 6 3/4 year $35,000,000 Term B loan facility. 



<PAGE>

During June 1997, the Company prepaid previously outstanding long-term bank 
debt with funds from the new credit agreement. In connection with the 
prepayment of those borrowings, the Company incurred an extraordinary loss of 
$1,370,000 (net of income taxes), or $0.15 per share. The loss primarily 
related to the write-off of debt issuance costs and the termination of two 
interest rate swap agreements.

Unless otherwise indicated, the following discussion relates only to the 
continuing operations of the Company, which are the domestic and 
international consumer products business. The results of operations and the 
gain on disposal of the specialty chemical division in 1995 have been 
separately classified as discontinued operations in the accompanying 
consolidated statements of income.

The Company experienced an increase in net sales, operating income and income 
from continuing operations for the year ended November 30, 1997. Net sales 
increased 20.5% to $143,235,000 from $118,903,000 in 1996. Operating income 
increased 52.8% to $25,503,000 from $16,689,000 in 1996. Income from 
continuing operations increased 90.7% to $7,255,000 from $3,804,000 in 1996, 
while net income, which includes extraordinary charges of $1,370,000 and 
$532,000 in 1997 and 1996, respectively, relating to the early extinguishment 
of debt in those respective years, increased 79.9% to $5,885,000 from 
$3,272,000 in fiscal year 1996.


                                       2


<PAGE>

In fiscal year 1997, earnings per share from continuing operations increased 
$0.33, or 70.2%, to $0.80 while total earnings per share increased $0.25, or 
62.5% to $0.65 when compared to the 1996 fiscal year.

The results of operations for fiscal year 1997 reflect a full year of 
operations of the GOLD BOND and HERPECIN-L product lines, both of which were 
acquired in mid-1996, and approximately five months' operations of the 
SUNSOURCE brands, which were purchased in mid-1997.

The Company will continue to seek increases in sales through a combination of 
acquisitions and internal growth while maintaining high operating income. As 
previously high growth brands mature, sales increases will become even more 
dependent on acquisitions and the development of successful line extensions. 
During the year ended November 30, 1997, new additions to the ICY HOT 
(Arthritis Therapy Gel), GOLD BOND (Medicated Foot Powder and CORNSTARCH PLUS 
Medicated Baby Powder), MUDD (5 Minute Mask) and PAMPRIN and PREMSYN PMS (Gel 
Caps) product lines as well as a newly repackaged CORNSILK line were 
introduced.

                                       3

<PAGE>

                             RESULTS OF OPERATIONS

The following table sets forth for continuing operations certain items from
the Company's consolidated statements of income, for the periods indicated,
expressed as a percentage of net sales:
 
<TABLE>
<CAPTION>

                                                                    YEAR ENDED NOVEMBER 30,
                                                               -------------------------------
<S>                                                            <C>        <C>        <C>
                                                                  1997       1996       1995
                                                               ---------  ---------  ---------
Net Sales..................................................      100.0%     100.0%     100.0%
                                                                 -----      -----      -----
Costs and Expenses:
Cost of sales..............................................       27.4       29.5       29.6
Advertising and promotion..................................       39.2       38.3       37.0
Selling, general and administrative........................       15.6       18.2       19.0
                                                                 -----      -----      -----
Total costs and expenses...................................       82.2       86.0       85.6
                                                                 -----      -----      -----
Income From Operations.....................................       17.8       14.0       14.4
Other Expense, Net.........................................       (9.9)      (9.3)     (10.8)
                                                                 -----      -----      -----
Income Before Income Taxes.................................        7.9        4.7        3.6
Provision For Income Taxes.................................        2.8        1.5        1.3
                                                                 -----      -----      -----
Income From Continuing Operations..........................        5.1%       3.2%       2.3%
                                                                 -----      -----      -----
                                                                 -----      -----      -----

</TABLE>



         FISCAL 1997 COMPARED TO FISCAL 1996 FOR CONTINUING OPERATIONS

For the year ended November 30, 1997, net sales increased $24,332,000, or 
20.5%, to $143,235,000 from $118,903,000 for the previous fiscal year. This 
increase consisted of a $23,580,000, or 22.6%, increase in domestic consumer 
products sales from $104,444,000 in 1996 to $128,024,000 in 1997 and an 
increase of $752,000, or 5.2%, in international sales to $15,211,000 from 
$14,459,000.


                                       4

<PAGE>


For domestic consumer products, sales of the GOLD BOND, HERPECIN-L, ICY HOT 
and the SUNSOURCE products accounted for the majority of the sales increase 
in 1997. Sales increases were also realized for the SUN-IN and MUDD brands. 
Sales declines were recognized for FLEXALL, NORWICH Aspirin, CORNSILK, 
BULLFROG and PHISODERM. The remaining domestic brands were basically flat or 
had modest declines over the prior fiscal year. All sales variances were 
largely the result of changes in volume.

The increase in sales of the SUN-IN brand was largely the result of increased 
marketing support, while the MUDD sales increase was primarily due to the 
addition of the 5 Minute Mask to the line in 1997 and the continuing effect 
of new packaging in late 1995. The sales increase of the ICY HOT brand 
reflects the line extension launched in early 1997 and a 68.0% increase in 
advertising and promotion expenditures in 1997 over 1996.

Sales declines for the remainder of the domestic products are primarily due 
to increased competition in their respective product categories, the 
maturation of these brands and in most cases reduced marketing support. The 
decline in sales of the BULLFROG brand reflects the loss of a major customer 
and the cool, wet spring experienced in 1997.


                                       5

<PAGE>


In fiscal 1997, sales for the international consumer products' segment 
increased $847,000, or 21.0%, for the Canadian operation but declined 
$252,000, or 2.6%, for the United Kingdom business. The GOLD BOND product 
line accounted for practically all of the net sales increase in Canada, 
although increases were also realized for the remainder of the product lines 
marketed in that country, except for ULTRASWIM and CORNSILK. Sales declines 
were recognized for all of the product lines marketed by the United Kingdom 
operation, except for MUDD. These sales decreases were largely due to a 
change in the United Kingdom from a dealer distribution system to one 
operated by the Company's U.K. subsidiary in that country. U.S. export sales 
increased $157,000, or 17.5%, in 1997 over 1996, with essentially all of the 
increase being associated with the ICY HOT brand. All sales variances were 
principally due to volume changes.

Cost of goods sold as a percentage of net sales in 1997 decreased to 27.4%
from 29.5% in 1996. The decrease was largely the result of a shift in product
mix of sales of domestic consumer products to higher margin products and the
addition of GOLD BOND and SUNSOURCE.


                                       6

<PAGE>

Advertising and promotion expenses increased $10,664,000, or 23.4%, to 
$56,176,000 in 1997 from $45,512,000 in 1996 and were 39.2% of net sales 
compared to 38.3% in 1996. This increase was principally associated with the 
GOLD BOND and HERPECIN-L brands, which were acquired in 1996; the SUNSOURCE 
product line, acquired in mid-1997; and ICY HOT. Increases in 1997 were also 
recorded for the PAMPRIN, PREMSYN PMS, ULTRASWIM and SUN-IN brands.

Selling, general and administrative expenses increased $721,000, or 3.3%, to 
$22,303,000 in 1997 from $21,582,000 in 1996, but decreased as a percentage 
of net sales to 15.6% in 1997 as compared to 18.2% in 1996. This increase was 
largely associated with increases in direct selling costs, freight and field 
sales expenses, resulting from increased sales, offset in part by reductions 
in financial and legal services expenses.

Interest expense increased $2,540,000, or 19.0%, to $15,934,000 in 1997 from 
$13,394,000 in 1996 primarily as a result of increased indebtedness 
associated with the GOLD BOND and HERPECIN-L product acquisitions in 1996 and 
the SUNSOURCE brands purchase in mid-1997. Interest expense is expected to 
increase in 1998 due to the full year impact of the higher debt levels 
associated with product acquisitions. Until the Company's indebtedness is 
reduced substantially, interest expense will continue to represent a 
significant percentage of the Company's net sales.


                                       7

<PAGE>


Investment and other income increased $229,000, or 15.8%, to $1,679,000 in 
1997 from $1,450,000 in 1996.

Provisions for income taxes were 35.5% of before tax income in 1997 as 
compared to 32.3% in 1996. See Note 8 of Notes to Consolidated Financial 
Statements.

Income from continuing operations increased $3,451,000, or 90.7%, to 
$7,255,000 in 1997 from $3,804,000 in 1996. This increase resulted primarily 
from increased sales and a more favorable product sales mix with regard to 
gross margins in 1997.


                                       8

<PAGE>


         FISCAL 1996 COMPARED TO FISCAL 1995 FOR CONTINUING OPERATIONS

Net sales for the year ended November 30, 1996 increased $18,305,000, or 
18.2%, to $118,903,000 from $100,598,000 for the previous fiscal year. The 
increase consisted of a $17,194,000, or 19.7%, increase in domestic consumer 
products sales from $87,250,000 in 1995 to $104,444,000 in 1996 and an 
increase of $1,111,000, or 8.3%, in international sales to $14,459,000 from 
$13,348,000.

For domestic consumer products, net sales of the GOLD BOND and HERPECIN-L 
product lines, both of which were acquired in 1996, and PHISODERM 
Antibacterial Hand Cleanser accounted for essentially all of the sales 
increase in 1996, although sales increases were also realized for the 
BULLFROG, ICY HOT and MUDD product lines. Sales declines were recognized for 
CORNSILK, NORWICH Aspirin and PHISODERM facial. The remaining domestic brands 
were basically flat or had modest declines over the prior fiscal year. All 
sales variances were largely the result of changes in sales volume.

The increase in sales of the BULLFROG and MUDD brands in 1996 was largely the 
result of new product introductions and/or new packaging in late 1995 and 
increased marketing support. Sales growth for the ICY HOT product line was 
primarily due to increased advertising and promotional expenditures. 


                                       9

<PAGE>

Sales declines for the remainder of the domestic products are essentially the 
result of increased competition in their respective product categories, the 
maturation of these brands and in most cases reduced marketing support.

In fiscal 1996, sales for the international consumer products' segment 
increased $121,000, or 3.1%, for the Canadian operation and $1,446,000, or 
17.9%, for the United Kingdom business. The addition of the GOLD BOND product 
line in Canada accounted for more than the total of the net sales increase in 
that country, although increases were also realized for the SUN-IN, ULTRASWIM 
and MUDD product lines. Declines in sales of the other brands in Canada 
largely offset the increases enumerated above. Sales increases for all of the 
product lines sold by the United Kingdom operation were realized with the 
exception of the CORNSILK brand. U.S. export sales decreased $456,000, or 
33.8%, in 1996 largely resulting from unfavorable general economic conditions 
in Peru and Mexico. All sales variances were principally due to volume 
changes.

Cost of goods sold as a percentage of net sales in 1996 was essentially 
unchanged at 29.5% versus 29.6% for 1995. Cost of goods sold was affected by 
the partial year positive impact of GOLD BOND which was offset by increased 
inventory obsolesence charges.


                                       10

<PAGE>


Advertising and promotion expenses increased $8,270,000, or 22.2%, to 
$45,512,000 in 1996 from $37,242,000 in 1995 and were 38.3% of net sales 
compared to 37.0% in 1995. This increase was principally associated with the 
GOLD BOND and HERPECIN-L brands, which were acquired in 1996, and with the 
introduction of PHISODERM Antibacterial Hand Cleanser in that year. Increases 
in 1996 were also recorded for the BULLFROG, FLEXALL, ICY HOT, SUN-IN and 
MUDD product lines.

Selling, general and administrative expenses increased $2,449,000, or 12.8%, 
to $21,582,000 in 1996 from $19,133,000 in 1995, but decreased as a 
percentage of net sales to 18.2% for 1996 as compared to 19.0% in 1995. This 
increase was largely associated with increases in direct selling costs, 
freight and field sales expenses, resulting from increased sales.

Interest expense increased $2,318,000, or 20.9%, to $13,394,000 in 1996 from 
$11,076,000 in 1995 largely as a result of increased indebtedness associated 
with the acquisition of the GOLD BOND and HERPECIN-L product lines in April 
and June, 1996, respectively.


                                       11

<PAGE>

Investment income increased $893,000 to $1,420,000 in 1996 from $527,000 in
1995. This increase consisted of $113,000 of interest income, resulting from the
temporary investment of excess funds; $328,000 of dividends on the cumulative,
convertible preferred stock of Elcat, Inc. received as part of the proceeds from
the sale of the specialty chemical division in 1995; and a gain of $452,000 on
the sale of an investment.

In 1996, a gain of $875,000 from the sale of the two minor product lines, 
SOLTICE and BLIS-TO-SOL, was realized.

Provisions for income taxes were 32.3% of before tax income in 1996 as 
compared to 35.6% in 1995. See Note 8 of Notes to Consolidated Financial 
Statements.

Income from continuing operations increased $1,479,000, or 63.6%, to 
$3,804,000 in 1996 from $2,325,000 in 1995. This increase resulted primarily 
from increased sales in 1996 which more than offset increased interest 
expense.


                                       12

<PAGE>

LIQUIDITY AND CAPITAL RESOURCES
-------------------------------

The Company has historically financed its operations and acquisitions with a 
combination of internally generated funds and borrowings. The Company's 
principal uses of cash are operating expenses, acquisitions, working capital, 
capital expenditures and long-term debt servicing.

Cash provided by operating activities was $10,116,000 and $2,858,000 for 1997 
and 1996, respectively. The increase in cash flows from operations from 1996 
to 1997 was primarily the result of increased net income, depreciation and 
amortization and changes in accounts receivable, refundable and deferred 
income taxes and inventories. These changes were impacted by the acquisition 
of the SUNSOURCE product line in 1997. 

Investing activities used cash of $32,722,000 and $47,708,000 in 1997 and 
1996, respectively. The usage of cash in 1997 reflects the expenditures 
required for the purchase of the SUNSOURCE brands, while the 1996 amount 
represents the cost of the GOLD BOND and HERPECIN-L product lines acquired in 
that year. In 1997, capital expenditures totaled $2,758,000 compared to 
$1,785,000 in 1996. Expenditures of this nature are expected to be 
approximately $3,000,000 in fiscal 1998.


                                       13

<PAGE>

Financing activities provided cash of $11,434,000 in 1997 and $57,125,000 in 
1996. The Company financed the acquisition of the SUNSOURCE brands and repaid 
all outstanding bank indebtedness with the proceeds of a new $95,000,000 bank 
credit agreement and the issuance of 300,000 new shares of the Company's 
common stock at a value of $13.50 a share to the sellers of SUNSOURCE. In the 
1996 period, the Company financed the acquisition of GOLD BOND and repaid all 
outstanding bank indebtedness.

The following table presents certain working capital data at November 30, 
1997 and 1996 or for the respective years then ended:

<TABLE>
<CAPTION>
                                    ITEM                                                 1997           1996
-----------------------------------------------------------------------------------  -------------  -------------
<S>                                                                                  <C>            <C>
Working capital (current assets less current liabilities)..........................  $  15,520,000  $  19,793,000
Current ratio (current assets divided by current liabilities)......................           1.45           1.75
Quick ratio (cash and cash equivalents, and receivables divided by current
  liabilities).....................................................................            .96           1.12
Average accounts receivable turnover...............................................           5.92           6.51
Average inventory turnover.........................................................           3.17           3.70
Working capital as a percentage of total assets....................................           8.68%         13.01%
</TABLE>

The decrease in the current and quick ratios at November 30, 1997 as compared 
to November 30, 1996 was primarily due to decreases in cash and refundable 
and deferred income taxes as well as increases in all components of current 
liabilities, particularly the current maturities of long-term debt.


                                       14

<PAGE>

Total debt outstanding was $142,394,000 at November 30, 1997 compared to 
$131,344,000 at November 30, 1996. The net increase of $11,050,000 in 1997 
reflects the acquisition of the SUNSOURCE product line in June, 1997 and 
repayments by the Company during the year. The availability of credit under 
the working capital line of credit is determined based on the Company's 
accounts receivable and inventories. The Company had $13,000,000 outstanding 
on its $30,000,000 working capital line of credit as of November 30, 1997. 
The Company had $4,349,000 invested in highly liquid short-term investments 
as of November 30, 1997.

Management of the Company believes that cash generated by operations, along 
with funds available from its short-term, highly liquid investments and 
available funds under its credit facility, will be sufficient to fund the 
Company's current commitments and proposed operations.

YEAR 2000
---------

The Company recognizes the need to ensure its operations will not be 
adversely impacted by year 2000 software failures. Software failures due to 
processing errors potentially arising from calculations using the year 2000 
date are a known risk. The Company has developed a plan to ensure its systems 
are compliant with the requirements to process transactions in the year 2000. 
The majority of the Company's internal information systems will be replaced 
with fully compliant new systems. The total cost of the software and 
implementation is estimated to be $1,500,000 to $2,000,000 which will be 
capitalized as


                                       15


<PAGE>

incurred. The majority of actual cash payments will be made in 1998 with the 
remainder to be paid in early 1999. This new system implementation is 
expected to be completed during 1999.

The Company does not currently have any information concerning the year 2000 
compliance status of its suppliers and customers. In the event that any of 
the Company's significant suppliers or customers does not successfully and 
timely achieve year 2000 compliance, the Company's business or operations 
could be adversely affected.

                                       16

<PAGE>

FOREIGN OPERATIONS
------------------

The Company's primary foreign operations are conducted through its Canadian 
and U.K. subsidiaries. The functional currencies of these subsidiaries are 
Canadian dollars and British pounds, respectively. Fluctuations in exchange 
rates can impact operating results, including total revenues and expenses, 
when translations of the subsidiary financial statements are made in 
accordance with SFAS No. 52, "Foreign Currency Translation." For the years 
ended November 30, 1997 and 1996, these subsidiaries accounted for 9.9% and 
11.4% of total revenues, respectively, and 4.5% and 5.8% of total assets, 
respectively. It has not been the Company's practice to hedge its assets and 
liabilities in the Canada and U.K. or its intercompany transactions due to 
the inherent risks associated with foreign currency hedging transactions and 
the timing of payment between the Company and its two foreign subsidiaries. 
Historically, gains or losses from foreign currency transactions have not had 
a material impact on the Company's operating results. Losses of $68,000 and 
$28,000 for the years ended November 30, 1997 and 1996, respectively, 
resulted from foreign currency transactions. See "Foreign Currency 
Translation" in Note 2 of Notes to the Consolidated Financial Statements.


                                       17

<PAGE>

FORWARD LOOKING STATEMENTS
--------------------------

This Management's Discussion and Analysis of Financial Condition and Results 
of Operations, the Chairman's Letter and other sections of this Annual Report 
contain forward looking statements that are based upon management's current 
beliefs and assumptions about expectations, estimates, strategies and 
projections for the Company. Words such as "expects," "anticipates," 
"intends," "plans," "believes," "seeks," "estimates" and variations of such 
words and similar expressions are intended to identify such forward looking 
statements. These statements are not guarantees of future performance and 
involve risks, uncertainties and assumptions that are difficult to predict. 
Therefore, actual outcomes and results may differ materially from what is 
expressed or forecasted in such forward looking statements. The Company 
undertakes no obligation to update publicly any forward looking statements 
whether as a result of new information, future events or otherwise.


                                       18

<PAGE>

The risks, uncertainties and assumptions regarding forward looking statements 
include, but are not limited to, product demand and market acceptance risks; 
product development risks, such as delays or difficulties in developing, 
producing and marketing new products or line extensions; the impact of 
competitive products, pricing and advertising; constraints resulting from the 
financial condition of the Company, including the degree to which the Company 
is leveraged, debt service requirements and restrictions under bank loan 
agreements and the indenture; and other risks described in the Company's 
Securities and Exchange Commission filings.
 
                                       19



<PAGE>
                            SELECTED FINANCIAL DATA
                   (In thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                                          YEAR ENDED NOVEMBER 30,
                                                         --------------------------------------------------------
                                                            1997        1996        1995       1994       1993
                                                         ----------  ----------  ----------  ---------  ---------
<S>                                                      <C>         <C>         <C>         <C>        <C>
INCOME STATEMENT DATA
 NET SALES.............................................  $  143,235  $  118,903  $  100,598  $  94,370  $  89,861
 OPERATING COSTS AND 
 EXPENSES..............................................     117,732     102,214      86,130     81,830     88,111
                                                         ----------  ----------  ----------  ---------  ---------
 INCOME FROM OPERATIONS................................      25,503      16,689      14,468     12,540      1,750

 OTHER EXPENSE, NET....................................     (14,255)    (11,069)    (10,858)    (9,248)    (3,489)
                                                         ----------  ----------  ----------  ---------  ---------
 INCOME (LOSS) FROM 
  CONTINUING OPERATIONS 
  BEFORE INCOME TAXES..................................      11,248       5,620       3,610      3,292     (1,739)

 PROVISION FOR (BENEFIT FROM) 
  INCOME TAXES.........................................       3,993       1,816       1,285      1,182       (639)
                                                         ----------  ----------  ----------  ---------  ---------
 INCOME (LOSS) FROM 
  CONTINUING OPERATIONS................................  $    7,255  $    3,804  $    2,325  $   2,110  $  (1,100)

 PER COMMON SHARE DATA 
  INCOME (LOSS) FROM 
  CONTINUING OPERATIONS................................  $      .80  $      .47  $      .32  $     .29  $    (.17)

 DIVIDENDS.............................................  $       --  $       --  $       --  $      --  $   20.20
BALANCE SHEET DATA 
 (At End of Period) 
 TOTAL ASSETS..........................................  $  178,744  $  152,183  $   83,410  $  85,442  $  69,534
 LONG-TERM DEBT, less 
  current maturities...................................  $  133,475  $  127,438  $   78,089  $  94,486  $  83,000
</TABLE>

                                      13
<PAGE>


MARKET PRICES

    The Company's common shares trade over-the-counter on the National Market
System under the NASDAQ symbol CHTT. A quarterly summary of the high and low
market prices per common share as reported by NASDAQ is shown below:
 
<TABLE>
<CAPTION>
                                                                                        1997                  1996
                                                                                --------------------  --------------------
QUARTER ENDED:                                                                    HIGH        LOW       HIGH        LOW
                                                                                ---------  ---------  ---------  ---------
<S>                                                                             <C>        <C>        <C>        <C>
February......................................................................     10          8 1/8      5 5/8      4 1/4
May...........................................................................     10 7/8      8          9 1/4      4 1/8
August........................................................................     18 3/4     10 1/4     10 1/4      7 3/4
November......................................................................     20 5/8     14 3/8     11 1/4      8 3/8
</TABLE>

    Based upon transfer agent records, the Company's common shares were held by
approximately 2,500 shareholders as of February 20, 1998.






                                      14
<PAGE>

                         Consolidated Balance Sheets 
                          November 30, 1997 and 1996 
                                 (In thousands)

<TABLE>
<CAPTION>

ASSETS                                                    1997            1996
                                                       ----------      ----------
<S>                                                    <C>             <C>
CURRENT ASSETS:
  Cash and cash equivalents........................    $    4,858      $   9,254
  Accounts receivable, less allowance for
  doubtful accounts of $500 in 1997 and $450
   in 1996.........................................        28,078         20,276
  Refundable and deferred income taxes.............         1,876          5,405
  Inventories......................................        14,493         10,295
  Prepaid expenses and other current
   assets..........................................           667            912
                                                       ----------      ---------
    Total current assets...........................        49,972         46,142
                                                       ----------      ---------
PROPERTY, PLANT AND EQUIPMENT, NET.................        10,988          9,774
                                                       ----------      ---------
OTHER NONCURRENT ASSETS:
  Investment in Elcat, Inc.........................         6,640          5,984
  Patents, trademarks and other purchased
   product rights, net.............................       104,972         76,024
  Debt issuance costs, net.........................         3,118          3,819
  Other............................................         3,054         10,440
                                                       ----------      ---------
    Total other noncurrent assets..................       117,784         96,267
                                                       ----------      ---------
      TOTAL ASSETS.................................      $178,744       $152,183
                                                       ----------      ---------
                                                       ----------      ---------
</TABLE>

    The accompanying notes are an integral part of these consolidated financial
statements.



                                      15


<PAGE>

                           Consolidated Balance Sheets
                            November 30, 1997 and 1996
                                 (In thousands)
 
<TABLE>
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)                                 1997        1996
                                                                            ----------  ----------
<S>                                                                         <C>         <C>
CURRENT LIABILITIES:
  Current maturities of long-term debt....................................  $    8,919  $    3,906
  Accounts payable........................................................       9,319       6,602
  Payable to bank.........................................................       2,618       1,710
  Accrued liabilities.....................................................      13,596      14,131
                                                                            ----------  ----------
    Total current liabilities.............................................      34,452      26,349
                                                                            ----------  ----------
LONG-TERM DEBT, less current maturities...................................     133,475     127,438
                                                                            ----------  ----------
DEFERRED INCOME TAXES.....................................................       3,290       2,917
                                                                            ----------  ----------
OTHER NONCURRENT LIABILITIES..............................................       3,157       2,659
                                                                            ----------  ----------
COMMITMENTS AND CONTINGENCIES (Notes 5, 10 and 12)

SHAREHOLDERS' EQUITY (DEFICIT):
  Preferred shares, without par value, 
   authorized 1,000, none issued..........................................          --          --
  Common shares, without par value, authorized 20,000, 
   issued 9,082 in 1997 and 8,592 in 1996.................................       1,945       1,843
  Paid-in surplus.........................................................      63,975      58,561
  Accumulated deficit.....................................................     (60,229)    (66,114)
                                                                            ----------  ----------
                                                                                 5,691      (5,710)
  Minimum pension liability adjustment....................................          --        (112)
  Foreign currency translation adjustment.................................      (1,321)     (1,358)
                                                                            ----------  ----------
    Total shareholders' equity (deficit)..................................       4,370      (7,180)
                                                                            ----------  ----------
     TOTAL LIABILITIES AND SHAREHOLDERS' 
      EQUITY (DEFICIT)....................................................  $  178,744  $  152,183
                                                                            ----------  ----------
</TABLE>

    The accompanying notes are an integral part of these consolidated financial
statements.

                                      16
<PAGE>

                        Consolidated Statements of Income 
              For the Years Ended November 30, 1997, 1996 and 1995 
                     (In thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                                                  1997        1996        1995
                                                                               ----------  ----------  ----------
<S>                                                                            <C>         <C>         <C>
NET SALES....................................................................  $  143,235  $  118,903  $  100,598
                                                                               ----------  ----------  ----------
COSTS AND EXPENSES:
  Cost of sales..............................................................      39,253      35,120      29,755
  Advertising and promotion..................................................      56,176      45,512      37,242
  Selling, general and administrative........................................      22,303      21,582      19,133
                                                                               ----------  ----------  ----------
    Total costs and expenses.................................................     117,732     102,214      86,130
                                                                               ----------  ----------  ----------
INCOME FROM OPERATIONS.......................................................      25,503      16,689      14,468
                                                                               ----------  ----------  ----------
OTHER INCOME (EXPENSE):
  Interest expense...........................................................     (15,934)    (13,394)    (11,076)
  Investment and other income, net...........................................       1,679       1,450         218
  Gain on product divestitures...............................................          --         875          --
                                                                               ----------  ----------  ----------
    Total other income (expense).............................................     (14,255)    (11,069)    (10,858)
                                                                               ----------  ----------  ----------

INCOME FROM CONTINUING OPERATIONS 
 BEFORE INCOME TAXES.........................................................      11,248       5,620       3,610

PROVISION FOR INCOME TAXES...................................................       3,993       1,816       1,285
                                                                               ----------  ----------  ----------
INCOME FROM CONTINUING OPERATIONS............................................       7,255       3,804       2,325
                                                                               ----------  ----------  ----------

DISCONTINUED OPERATIONS:
  Income from operations, less provision for 
   income taxes of $417......................................................          --          --         674
  Gain on disposal, less provision for 
   income taxes of $5,696....................................................          --          --       9,334
                                                                               ----------  ----------  ----------
  Income from discontinued operations........................................          --          --      10,008
                                                                               ----------  ----------  ----------
INCOME BEFORE EXTRAORDINARY LOSS.............................................       7,255       3,804      12,333
EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT 
  OF DEBT, NET OF INCOME TAXES (Note 5)......................................      (1,370)       (532)       (367)
                                                                               ----------  ----------  ----------
NET INCOME...................................................................  $    5,885  $    3,272  $   11,966
                                                                               ----------  ----------  ----------
                                                                               ----------  ----------  ----------
NET INCOME (LOSS) PER COMMON SHARE:
  Continuing operations......................................................  $      .80  $      .47  $      .32
  Discontinued operations....................................................          --          --        1.37
  Extraordinary loss.........................................................        (.15)       (.07)       (.05)
                                                                               ----------  ----------  ----------
    Net income per common share..............................................  $      .65  $      .40  $     1.64
                                                                               ----------  ----------  ----------
                                                                               ----------  ----------  ----------
WEIGHTED AVERAGE NUMBER OF COMMON 
 AND COMMON EQUIVALENT SHARES 
 OUTSTANDING.................................................................       9,124       8,153       7,292
                                                                               ----------  ----------  ----------
                                                                               ----------  ----------  ----------

</TABLE>
 
    The accompanying notes are an integral part of these consolidated financial
statements.
 
                                      17
<PAGE>


            Consolidated Statements of Shareholders' Equity (Deficit)
              For the Years Ended November 30, 1997, 1996 and 1995
                                 (In thousands)
 
<TABLE>
<CAPTION>
                                                                                            MINIMUM       FOREIGN
                                                                                            PENSION      CURRENCY
                                                     COMMON      PAID-IN   ACCUMULATED     LIABILITY    TRANSLATION
                                                     SHARES      SURPLUS     DEFICIT      ADJUSTMENT    ADJUSTMENT     TOTAL
                                                   -----------  ---------  ------------  -------------  -----------  ----------
<S>                                                <C>          <C>        <C>           <C>            <C>          <C>
Balance, November 30, 1994.......................   $   1,519   $  51,797   $  (81,352)           --     $  (1,515)  $  (29,551)
 Net income......................................          --          --       11,966            --            --       11,966
 Stock options granted...........................          --         302           --            --            --          302
 Foreign currency translation adjustment.........          --          --           --            --          (138)        (138)
                                                   -----------  ---------  ------------          ---    -----------  ----------
Balance, November 30, 1995.......................       1,519      52,099      (69,386)           --        (1,653)     (17,421)
 Net income......................................          --          --        3,272            --            --        3,272
 Stock options exercised.........................          63         223           --            --            --          286
 Issuance of common shares.......................         261       6,239           --            --            --        6,500
 Foreign currency translation adjustment.........          --          --           --            --           295          295
 Minimum pension liability adjustment............          --          --           --          (112)           --         (112)
                                                   -----------  ---------  ------------          ---    -----------  ----------
Balance, November 30, 1996.......................       1,843      58,561      (66,114)         (112)       (1,358)      (7,180)
 Net income......................................          --          --        5,885            --            --        5,885
 Stock options exercised.........................          25         962           --            --            --          987
 Stock warrants exercised........................          15         464           --            --            --          479
 Issuance of common shares.......................          62       3,988           --            --            --        4,050
 Foreign currency translation adjustment.........          --          --           --            --            37           37
 Minimum pension liability adjustment............          --          --           --           112            --          112
                                                   -----------  ---------  ------------          ---    -----------  ----------
Balance, November 30, 1997.......................   $   1,945   $  63,975   $  (60,229)    $      --     $  (1,321)  $    4,370
                                                   -----------  ---------  ------------          ---    -----------  ----------
                                                   -----------  ---------  ------------          ---    -----------  ----------
</TABLE>
 
    The accompanying notes are an integral part of these consolidated financial
statements.
 
                                      18
<PAGE>
                      Consolidated Statements of Cash Flows
               For the Years Ended November 30, 1997, 1996 and 1995
                                 (In thousands)
 
<TABLE>
<CAPTION>
                                                                                      1997       1996       1995
                                                                                    ---------  ---------  ---------
<S>                                                                                 <C>        <C>        <C>
OPERATING ACTIVITIES:
 Net income.......................................................................  $   5,885  $   3,272  $  11,966
 Adjustments to reconcile net income to net cash provided by 
  operating activities:
  Depreciation and amortization...................................................      6,381      4,829      4,072
  Deferred income tax provision...................................................      1,120      1,797        645
  Gain on sale of specialty chemicals division....................................         --         --     (9,334)
  Gain on product divestitures....................................................         --       (875)        --
  Gain on sale of investment......................................................         --       (452)        --
  Proceeds from sale of investment................................................         --        452         --
  Gain on termination of interest rate cap........................................         --       (281)      (454)
  Extraordinary loss on early extinguishment of debt, net.........................      1,370        532        367
  Dividend receivable from Elcat, Inc.............................................       (656)      (656)      (328)
  Other, net......................................................................       (106)      (379)     2,251
  Changes in operating assets and liabilities:
   Accounts receivable............................................................     (5,140)    (3,063)     1,973
   Refundable and deferred income taxes...........................................      3,425     (2,519)       106
   Inventories....................................................................     (2,401)       745     (2,488)
   Prepaid expenses and other current assets......................................        252       (359)      (166)
   Accounts payable and accrued liabilities.......................................        (14)      (185)    (7,780)
                                                                                    ---------  ---------  ---------
  Net cash provided by operating activities.......................................     10,116      2,858        830
                                                                                    ---------  ---------  ---------
INVESTING ACTIVITIES:
 Purchases of property, plant and equipment.......................................     (2,758)    (1,785)    (2,836)
 Proceeds from sale of specialty chemicals division, net..........................         --         --     19,397
 Proceeds from product divestitures...............................................         --      1,000         --
 Proceeds from notes and sales of assets..........................................         75        253        227
 Purchases of patents, trademarks and other product rights........................    (29,293)   (43,048)        --
 Increase in other assets.........................................................       (746)    (4,128)       (26)
                                                                                    ---------  ---------  ---------
  Net cash provided by (used in) investing activities.............................    (32,722)   (47,708)    16,762
                                                                                    ---------  ---------  ---------
FINANCING ACTIVITIES:
 Repayment of long-term debt......................................................    (76,636)   (15,032)   (48,704)
 Proceeds from long-term debt.....................................................     87,500     67,944     31,100
 Change in payable to bank........................................................        908        526       (117)
 Proceeds from sale of interest rate cap..........................................         --         --        984
 Proceeds from issuance of common stock, net......................................         --      5,500         --
 Exercise of stock options and warrants...........................................      1,274        286         --
 Debt issuance costs..............................................................     (1,612)    (2,099)      (253)
                                                                                    ---------  ---------  ---------
  Net cash provided by (used in) financing activities.............................     11,434     57,125    (16,990)
                                                                                    ---------  ---------  ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 
  AND CASH EQUIVALENTS............................................................        (10)       129         --

CASH AND CASH EQUIVALENTS:
 Increase (decrease) for the year.................................................    (11,182)    12,404        602
 At beginning of year.............................................................     16,040      3,636      3,034
                                                                                    ---------  ---------  ---------
 At end of year...................................................................  $   4,858  $  16,040  $   3,636
                                                                                    ---------  ---------  ---------
                                                                                    ---------  ---------  ---------
</TABLE>
   The accompanying notes are an integral part of these consolidated 
financial statements
                                      19


<PAGE>
 
                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE: All monetary amounts are expressed in thousands of dollars unless
contrarily evident. 

(1) NATURE OF OPERATIONS
 
    Chattem, Inc. and its wholly-owned subsidiaries (the Company) manufacture
and market branded consumer products consisting primarily of over-the-counter
pharmaceuticals, cosmetics, toiletries, dietary supplements and homeopathics.
The consumer products are sold primarily through independent and chain drug
stores, drug wholesalers, mass merchandisers and food stores in the United
States and in various markets in approximately 50 countries throughout the
world.
 
    Geographic data for 1997, 1996 and 1995 is included in the schedule of
geographical information on page 37, which is an integral part of these
financial statements. 

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
BASIS OF CONSOLIDATION
 
    The accompanying consolidated financial statements include the accounts of
Chattem, Inc. and its wholly-owned subsidiaries. All significant intercompany
transactions and balances have been eliminated.
 
CASH AND CASH EQUIVALENTS
 
    For purposes of reporting cash flows, the Company considers all short-term
deposits and investments with original maturities of three months or less to be
cash equivalents, including cash and cash equivalents available exclusively for
the repayment of long-term debt (Note 5).
 
INVENTORIES
 
    Inventory costs include materials, labor and factory overhead. Inventories
in the United States are valued at the lower of last-in, first-out (LIFO) cost
or market, while international inventories are valued at the lower of first-in,
first-out (FIFO) cost or market.
 
PROPERTY, PLANT AND EQUIPMENT
 
    Property, plant and equipment are recorded at cost. Depreciation is provided
using both straight-line and accelerated methods over the estimated useful lives
of 10 to 40 years for buildings and improvements and 3 to 12 years for machinery
and equipment. Expenditures for maintenance and repairs are charged to expense
as incurred. Depreciation expense for 1997, 1996 and 1995 was $1,502, $1,352 and
$1,319, respectively.

                                       20
<PAGE>
 
PATENTS, TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS
 
    The costs of acquired patents, trademarks and other purchased product rights
are capitalized and amortized over periods ranging from 5 to 40 years. Total
accumulated amortization of these assets at November 30, 1997 and 1996 was
$11,246 and $8,369, respectively. Amortization expense for 1997, 1996 and 1995
was $2,877, $2,086 and $1,467, respectively. Royalty expense related to other
purchased product rights for 1997, 1996 and 1995 was $522, $1,140 and $1,030,
respectively. Amortization and royalty expense are included in advertising and
promotion expense in the accompanying consolidated statements of income.
 
DEBT ISSUANCE COSTS
 
    The Company has incurred debt issuance costs in connection with its
long-term debt. These costs are capitalized and amortized over the term of the
debt. Amortization expense related to debt issuance costs was $490, $498 and
$471 in 1997, 1996 and 1995, respectively. Accumulated amortization of these
costs was $1,004 and $817 at November 30, 1997 and 1996, respectively.
 
PAYABLE TO BANK
 
    Payable to bank includes checks outstanding in excess of certain cash
balances.
 
REVENUE RECOGNITION
 
    Revenue is recognized when the Company's products are shipped to its
customers.
 
RESEARCH AND DEVELOPMENT
 
    Research and development costs relate primarily to the development of new
products and are expensed as incurred. Such expenses were $1,207, $1,117 and
$1,140 in 1997, 1996 and 1995, respectively.
 
ADVERTISING EXPENSES
 
    The cost of advertising is expensed when the related advertising first takes
place. Advertising expense for 1997, 1996 and 1995 was $29,923, $22,789 and
$18,015, respectively. At November 30, 1997 and 1996, the Company reported
$1,066 and $1,293, respectively, of advertising paid for in 1997 and 1996 which
will run or did in 1998 and 1997 as other noncurrent assets in the accompanying
consolidated balance sheets.

                                       21
<PAGE>
 
NET INCOME PER COMMON SHARE
 
    Net income per common share is based on the weighted average number of
common shares outstanding after consideration of common share equivalents having
a dilutive effect.
 
FOREIGN CURRENCY TRANSLATION
 
    Assets and liabilities of the Company's Canadian and UK Subsidiaries are 
translated to United States dollars at year-end exchange rates. Income and 
expense items are translated at average rates of exchange prevailing during 
the year. Translation adjustments are accumulated as a separate component of 
shareholders' equity (deficit). Gains and losses which result from foreign 
currency transactions are included in the accompanying consolidated 
statements of income.
 
INCOME TAXES
 
    The Company uses the asset and liability approach to accounting for deferred
income taxes based on currently enacted tax rates and estimated differences in
financial reporting and income tax bases of assets and liabilities.
 
USE OF ESTIMATES
 
    The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
 
DERIVATIVE FINANCIAL INSTRUMENTS
 
    The Company has entered into interest rate swap agreements as a means of
managing its interest rate exposure and not for trading purposes. These
agreements have the effect of converting a portion of the Company's variable
rate obligations to fixed rate obligations. Net amounts paid or received are
reflected as adjustments to interest expense.
 
                                       22
<PAGE>

CONCENTRATIONS OF CREDIT RISK
 
    Financial instruments which subject the Company to concentrations of credit
risk consist primarily of accounts receivable, short-term cash investments and
the investment in Elcat, Inc. (Note 3). The Company's exposure to credit risk
associated with nonpayment of accounts receivable is affected by conditions or
occurrences within the retail industry. As a result, the Company performs
ongoing credit evaluations of its customers' financial position but generally
requires no collateral from its customers. The Company's largest customer
accounted for 16% of sales in 1997. No other customer exceeded 10% of the
Company's sales in 1997, 1996 or 1995. Short-term cash investments are placed
with high credit-quality financial institutions or in low risk, liquid
instruments. No losses have been experienced on such investments.
 
RECENT ACCOUNTING PRONOUNCEMENT

In 1997, the Financial Accounting Standards Board issued SFAS No. 128, 
"Earnings Per Share." SFAS No. 128 changes the criteria for reporting 
earnings per share (EPS) by replacing primary EPS with basic EPS and fully 
diluted EPS with diluted EPS. The Company is required to adopt SFAS No. 128 
for periods ending after December 15, 1997, and all prior periods' EPS data 
must be restated. The impact of adopting SFAS No.128 will not have a material 
impact on EPS for any period presented.

RECLASSIFICATIONS
 
    Certain prior year amounts have been reclassified to conform to the 1997
presentation. 

(3) INVESTMENT IN ELCAT, INC.
 
    Investment in Elcat, Inc. (Elcat) consists of 40,000 shares of 13.125%
cumulative, convertible preferred stock of Elcat (the Elcat Preferred Shares)
which was received as part of the consideration from the sale of the Company's
specialty chemicals division in 1995 (Note 14). The Elcat Preferred Shares are
nonvoting and are convertible, in whole or in part, at any time on or after
April 1, 1998, into a 21% common stock ownership of Elcat. At the option of
Elcat, the Elcat Preferred Shares may be redeemed, in whole or in part, on or
after April 1, 1998, at par value ($125 per share) plus any accrued and unpaid
dividends. If all of the then outstanding Elcat Preferred Shares are not
converted or redeemed on or before April 1, 2005, Elcat is obligated to redeem
all of the then outstanding Elcat Preferred Shares at par value plus any accrued
and unpaid dividends.
 
    The dividends, which amount to $656 annually, on the Elcat Preferred Shares
accumulate quarterly but are non-payable until the shares are called or
redeemed. After three years, however, if the shares are still outstanding, a
cash dividend of $200 will be received by the Company in fiscal year 1999,
increasing ratably to the full $656 in fiscal year 2002.
 
    This investment is classified as held-to-maturity and is accounted for using
the cost method of accounting. As Elcat stock is not publicly traded in the open
market and a market price is not readily available, it is not practicable to
estimate the fair value of the investment in Elcat at November 30, 1997. In the
opinion of management, however, the fair value of this investment is in excess
of its carrying value as of November 30, 1997. 

(4) PENSION PLANS
 
    The Company has a noncontributory defined benefit pension plan (the Plan)
which covers substantially all employees. The Plan provides benefits based upon
years of service and the employee's compensation. The Company's contributions
are based on computations by independent actuaries. Plan assets at November 30,
1997 and 1996 were invested primarily in United States government and agency
securities, corporate debt securities and equity securities.
 
                                       23
<PAGE>

    Pension cost for the years ended November 30, 1997, 1996 and 1995 included
the following components:
 
<TABLE>
<CAPTION>
                                                                   1997       1996       1995
                                                                 ---------  ---------  ---------
<S>                                                              <C>        <C>        <C>
Service cost (benefits earned during the period)...............  $     545  $     610  $     544
Interest cost on projected benefit obligation..................        741        775        745
Actual return on plan assets...................................       (845)      (637)      (828)
Net amortization and deferral..................................        365        107         98
                                                                 ---------  ---------  ---------
Net pension cost...............................................  $     806  $     855  $     559
                                                                 ---------  ---------  ---------
                                                                 ---------  ---------  ---------
</TABLE>
 
    In addition to net pension cost, a net lump-sum settlement loss of $598 was
recorded in 1996 related to lump-sum distributions to certain employees. This
expense is included in selling, general and administrative expenses in the
accompanying consolidated statements of income. In 1995, as a result of the sale
of the Company's specialty chemicals division, a charge of $662 was recognized
for pension curtailment and settlement expense and is included in the gain on
the sale of discontinued operations for 1995 (Note 14).
 
    The following table sets forth the funded status of the Plan as of 
November 30, 1997 and 1996:
 
<TABLE>
<CAPTION>
                                                                              1997       1996
                                                                            ---------  ---------
<S>                                                                         <C>        <C>
Actuarial present value of benefit obligations:
Vested benefit obligation.................................................  $   7,108  $   7,152
Nonvested benefit obligation..............................................         57        129
                                                                            ---------  ---------
Accumulated benefit obligation............................................  $   7,165  $   7,281
                                                                            ---------  ---------
                                                                            ---------  ---------
Plan assets at fair market value..........................................  $   6,471  $   5,069
Projected benefit obligation..............................................    (11,072)    (9,340)
                                                                            ---------  ---------
Plan assets less than projected benefit obligation........................     (4,601)    (4,271)
Unrecognized net loss.....................................................      4,186      2,898
Unrecognized prior service cost...........................................       (131)      (147)
Unrecognized initial asset................................................       (369)      (511)
Minimum pension liability adjustment......................................     --           (181)
                                                                            ---------  ---------
Pension liability recognized in balance sheets at end of year.............  $    (915) $  (2,212)
                                                                            ---------  ---------
                                                                            ---------  ---------
</TABLE>
 
    The discount rate and rate of increase in future compensation levels used in
determining the actuarial present value of the projected benefit obligation were
7.5% and 5.0%, respectively, in both 1997 and 1996. The expected long-term rate
of return on plan assets was 9.0%.
 
                                       24
<PAGE>

    In accordance with the provisions of SFAS No. 87, "Employers' Accounting 
for Pensions," the Company recorded an additional liability at November 30, 
1996 representing the excess of the accumulated benefit obligation over the 
fair value of plan assets and accrued pension liability for its pension plan. 
At November 30, 1997, the unrecognized prior service cost exceeded the 
minimum liability, and the minimum pension liability was eliminated.
 

    The Company has a defined contribution plan covering substantially all
employees. Eligible participants can contribute up to 10% of their annual
compensation and receive a 25% matching employer contribution up to 6% of their
annual compensation. The defined contribution plan expense was $155 for 1997,
$120 for 1996 and $141 for 1995. 

(5) LONG-TERM DEBT
 
    Long-term debt consisted of the following at November 30, 1997 and 1996:
 
<TABLE>
<CAPTION>
                                            1997              1996
                                      -----------------  -----------------
<S>                                   <C>                <C> 
Revolving line of credit payable to
  banks at variable rate (8.44%
  at November 30, 1997).............      $ 13,000            $   --
Term loans payable to banks at       
  variable rates (8.71% weighted 
  average at November 30, 1997).....        63,683                --
Revolving line of credit payable to       
  banks at variable rates, repaid in
  1997..............................          --                24,000
Term loans payable to banks at                         
  variable rates, repaid in 1997....          --                41,819
12.75% Senior Subordinated Notes,
  due 2004, net of unamortized
  discount of $1,289 for 1997 and
  $1,475 for 1996...................        65,711              65,525
                                      -----------------  -----------------
Total long-term debt................       142,394             131,344
Less: current maturities............         8,919               3,906
                                      -----------------  -----------------
Total long-term debt, net of current
  maturities........................      $133,475            $127,438
                                      -----------------  -----------------
                                      -----------------  -----------------
</TABLE>
 
    The Company entered into a new credit agreement with a syndicate of banks
(the New Credit Agreement) on June 26, 1997. The purpose of the New Credit
Agreement was to finance the acquisition of SUNSOURCE (Note 12), and to repay
all existing bank debt. The New Credit Agreement is divided into a $30,000
revolving line of credit for working capital purposes, a five year $30,000 Term
A loan and a six and three-quarter year $35,000 Term B loan facility.
 
    The combined Term A and B loans are payable in remaining quarterly
installments as follows:
 
<TABLE>
<S>                                                       <C>
December 31, 1997 to September 30, 1998.................  $   1,318
December 31, 1998 to September 30, 1999.................  $   1,488
December 31, 1999 to June 30, 2001......................  $   1,738
September 30, 2001......................................  $   2,650
December 31, 2001 to March 31, 2002.....................  $   4,900
June 30, 2002...........................................  $   5,000
September 30, 2002 to December 31, 2003.................  $   3,250
February 14, 2004.......................................  $   3,350
</TABLE>

                                       25
<PAGE>

    Under the New Credit Agreement the Company may elect either a prime rate 
or Eurodollar interest rate option applicable to the term and revolving line 
loans. The prime rate and Eurodollar interest rate options are based on a 
base rate plus a rate margin that fluctuates on the basis of the Company's 
leverage ratio. The maximum rate margin for the Term A and revolving line 
loans is 2.0% for the prime rate option and 3.0% for the Eurodollar rate 
option. The maximum rate margin for the Term B loan is 2.5% for the prime 
rate option and 3.5% for the Eurodollar rate option.

    The New Credit Agreement is secured by substantially all of the Company's 
assets. The more restrictive financial covenants require the maintenance of 
minimum amounts of consolidated tangible net worth, fixed charge coverage, 
interest coverage and leverage ratios. The provisions of the New Credit 
Agreement also include restrictions on capital expenditures and the payment 
of dividends. The New Credit Agreement is guaranteed by one of the Company's 
subsidiaries, Signal Investment & Management Co.

    The revolving line of credit is available to the Company up to $30,000 or 
such lesser amount as is determined to be available under the terms of the 
New Credit Agreement, and is due and payable on June 26, 2002. The 
availability of credit under the revolver is determined based on the 
Company's accounts receivable and inventories.

    The Company entered into a credit agreement with a syndicate of banks 
(the Credit Agreement) on April 29, 1996 and as amended on June 6, 1996. The 
purpose of the Credit Agreement was to finance the acquisitions of GOLD BOND 
and HERPECIN-L (Note 12), and to repay all existing bank debt. The Credit 
Agreement was divided into a $24,000 revolving line of credit for working 
capital purposes, a five year $20,000 Term A loan facility, and a seven and 
one-half year $22,500 Term B loan facility. These loans were repaid in 1997 
with part of the proceeds from the New Credit Agreement.

    The amount of cash and cash equivalents on deposit up to the calculated 
availability was included in other noncurrent assets in the accompanying 
consolidated balance sheet at November 30, 1996 and was available exclusively 
for the repayment of long-term bank debt. The amount of cash and cash 
equivalents on deposit in excess of the calculated availability is included 
as a current asset in the accompanying consolidated balance sheet at November 
30, 1996 and was available for general operating purposes. All of the above 
cash and cash equivalents were invested in highly liquid short-term 
investments.

    In 1994, the Company issued $75,000 of 12.75% Senior Subordinated Notes 
due 2004 (the Notes) with five year warrants to purchase 417,182 shares of 
common stock (the Warrants). The Notes consisted of 75,000 units, each 
consisting of $1,000 principal amount of the Notes and a warrant to purchase 
shares of the Company's common stock (Note 9). The price of the Notes was 
$73,967, or 98.6% of the original principal amount of the Notes, resulting in 
a discount of $1,033. The value assigned to the Warrants was $955 (Note 9), 
resulting in a total original issue discount of $1,988. The proceeds of the 
Notes were used to repay a prior credit agreement.

                                      26

<PAGE>

    The Notes mature on June 15, 2004, and interest is payable semi-annually 
on June 15 and December 15 of each year. The Notes are senior subordinated 
obligations of the Company and are subordinated in right of payment to all 
existing and future senior debt of the Company. The Notes, which were 
registered under the Securities Act of 1933, may not be redeemed until June 
15, 2001, after which they may be redeemed at the option of the Company. Upon 
the occurrence of certain events constituting a change of control, the 
holders of the Notes may require the Company to repurchase the Notes at a 
purchase price equal to 101% of the principal amount thereof, plus accrued 
and unpaid interest. The Notes are guaranteed by Signal Investment & 
Management Co., a wholly-owned subsidiary of the Company.

    The Notes are issued under an indenture with an indenture trustee, which 
restricts, among other things, the ability of the Company and its 
subsidiaries to (i) incur additional indebtedness, (ii) pay dividends, (iii) 
sell or issue capital stock of a subsidiary, (iv) create encumbrances on the 
ability of any subsidiary to pay dividends or make other restricted payments, 
(v) engage in certain transactions with affiliates, (vi) dispose of certain 
assets, (vii) merge or consolidate with or into, or sell or otherwise 
transfer all or substantially all their properties and assets as an entirety 
to another person, or (viii) create additional liens.

    During 1997, 1996 and 1995 the Company prepaid previously outstanding 
long-term debt, with funds received from refinancing in 1997 and 1996 and the 
sale of the specialty chemicals division in 1995. In connection with the 
prepayment of those borrowings, the Company incurred extraordinary losses, 
net of income taxes, in 1997, 1996 and 1995 of $1,370, $532 and $367, 
respectively, or $.15, $.07 and $.05 per share, respectively. The losses 
related to the write-off of debt issuance and other deferred costs. The 1997 
amount includes costs associated with the termination of two interest rate 
swap agreements.

    Future maturities of long-term debt are as follows:

<TABLE>
<S>                                  <C>
1998...............................  $   8,919
1999...............................      5,950
2000...............................      6,950
2001...............................      7,863
2002...............................     31,050
Thereafter.........................     82,951
                                     ---------
                                       143,683
Less: unamortized discount.........     (1,289)
                                     ---------
                                     $ 142,394
                                     ---------
                                     ---------
</TABLE>

    The 2002 maturities include the amount outstanding under the revolving 
line of credit which was $13,000 as of November 30, 1997.

    The Company is also required to pay $3,649 during 1998. This amount was 
determined based upon the excess cash flow calculation, as defined in the New 
Credit Agreement, and is included in the 1998 maturities.

    Cash interest payments during 1997, 1996 and 1995 were $15,259, $12,710 
and $10,811, respectively.

                                      27

<PAGE>

(6) DERIVATIVE FINANCIAL INSTRUMENTS

    On July 21, 1997, the Company entered into two interest rate swap 
agreements with NationsBank, N.A. in notional amounts of $40,000 and $5,000. 
The Company entered into these agreements as hedges on its variable rate debt 
and not for trading purposes. The term of the $40,000 swap is for a five year 
period ending July 22, 2002. The Company will receive interest payments on 
the notional amount at a rate equal to the one month London Interbank Offered 
Rate (LIBOR) (5.59% as of November 30, 1997) and will pay interest on the 
same notional amount at a fixed interest rate of 6.38%. The term of the 
$5,000 swap is for a five year period ending July 22, 2002. The agreement may 
be terminated by NationsBank, N.A. at each quarterly date. The Company will 
receive interest payments on the notional amount at a rate equal to the three 
month LIBOR (5.64% as of November 30, 1997) and will pay interest on the same 
notional amount at a fixed interest rate of 5.62%.

    The Company is exposed to credit losses in the event of nonperformance by 
the counterparty to its interest rate swap agreements but has no off-balance 
sheet credit risk of accounting loss. The Company anticipates, however, that 
the counterparty will be able to fully satisfy its obligations under the 
agreements.

    At November 30, 1996, the Company had two interest rate swap agreements 
outstanding with financial institutions, each in a notional amount of 
$15,000. Both of these interest rate swaps were terminated in 1997 in 
connection with the refinancing of long-term debt. (Note 5). The resulting 
extraordinary loss, net of tax, is included in the 1997 consolidated 
statement of income as part of the extraordinary loss on the early 
extinguishment of debt.

    During June 1993, the Company entered into an interest rate cap agreement 
in a notional principal amount of $30,000. On January 12, 1995, the interest 
rate cap was terminated resulting in a gain of approximately $729 to the 
Company. The gain was deferred and was amortized over the remaining life of 
the original cap agreement as a reduction of interest expense. In 1996, the 
remaining deferred gain of $281 was recognized.


(7) FAIR VALUE OF FINANCIAL INSTRUMENTS

    SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," 
and SFAS No. 119, "Disclosure about Derivative Financial Instruments and Fair 
Value of Financial Instruments" require the disclosure of the fair value of 
all financial instruments. Unless otherwise indicated elsewhere in the notes 
to the consolidated financial statements, the carrying value of the Company's 
financial instruments approximates fair value.

    At November 30, 1997, the estimated fair values of the revolving line of 
credit and the term loans payable to banks approximate the carrying amounts 
of such debt because the interest rates change with market interest rates.

    The estimated fair value of the Notes at November 30, 1997 exceeded their 
carrying value by approximately $9,600. The fair value was estimated based on 
quoted market prices for the same or similar issues.

                                      28

<PAGE>

    The fair values of the interest rate swap agreements are the estimated 
amounts that the Company would receive or pay to terminate the agreements at 
the reporting date, taking into account current interest rates and the 
current credit worthiness of the counterparties. At November 30, 1997, the 
Company estimates it would have paid $603 to terminate the agreements.

(8) INCOME TAXES

    The provision for income taxes from continuing operations includes the 
following components:

<TABLE>
<CAPTION>
                         1997       1996       1995
                      ---------  ---------  ---------
<S>                   <C>        <C>        <C>
Current:
  Federal...........  $   2,639  $    (203) $     470
  State.............        234        222        170
Deferred............      1,120      1,797        645
                      ---------  ---------  ---------
                      $   3,993  $   1,816  $   1,285
                      ---------  ---------  ---------
                      ---------  ---------  ---------
</TABLE>

    Deferred income tax assets and liabilities for 1997 and 1996 reflect the 
impact of temporary differences between the amounts of assets and liabilities 
for financial reporting and income tax reporting purposes. Temporary 
differences and carryforwards which give rise to deferred tax assets and 
liabilities at November 30, 1997 and 1996 are as follows:

<TABLE>
<CAPTION>
                                                            1997       1996
                                                         ---------  ---------
<S>                                                      <C>        <C>
Deferred tax assets:
  Reserves and accruals................................  $   2,005  $   1,790
  Accrued promotional expenses.........................        720        770
  Accrued postretirement health care benefits..........        559        535
  Repriced stock option expense........................        251        690
  Accruals for discontinued operations.................     --            237
  Other................................................        310        260
                                                         ---------  ---------
    Gross deferred tax assets..........................      3,845      4,282
                                                         ---------  ---------
Deferred tax liabilities:
  Excess tax depreciation and amortization.............      4,486      3,317
  Prepaid advertising..................................        318        309
  Inventory............................................        190        190
  Other................................................        277        772
                                                         ---------  ---------
    Gross deferred tax liabilities.....................      5,271      4,588
                                                         ---------  ---------
    Net deferred liability.............................  $  (1,426) $    (306)
                                                         ---------  ---------
                                                         ---------  ---------
</TABLE>

                                      29

<PAGE>

    The difference between the provision for income taxes and the amount 
computed by multiplying income from continuing operations before income taxes 
by the U.S. statutory rate is summarized as follows:

<TABLE>
<CAPTION>
                                                                      1997       1996       1995
                                                                   ---------  ---------  ---------
<S>                                                                <C>        <C>        <C>
Expected tax provision...........................................  $   3,837  $   1,911  $   1,227
Dividend exclusion benefit.......................................       (178)      (140)       (78)
State income taxes, net of federal income tax benefit............        154        147        112
Other, net.......................................................        180       (102)        24
                                                                   ---------  ---------  ---------
                                                                   $   3,993  $   1,816  $   1,285
                                                                   ---------  ---------  ---------
                                                                   ---------  ---------  ---------
</TABLE>

    Included in "refundable and deferred income taxes" in current assets in 
the accompanying consolidated balance sheets are income tax refunds 
receivable of $12 and $2,794 at November 30, 1997 and 1996, respectively.

    Income taxes paid in 1997, 1996 and 1995 were $2,162, $2,459 and $5,026, 
respectively. The Company received income tax refunds of $2,719, $215 and 
$163 during 1997, 1996 and 1995, respectively.


(9) SHAREHOLDERS' EQUITY (DEFICIT)

STOCK ISSUANCE

    On June 26, 1997, the Company issued to the sellers of the SUNSOURCE 
product line 300,000 shares of its common stock at a value of $13.50 per 
share to fund a portion of the purchase price for the brands.

    In April 1996, the Company issued 1,100,000 shares of common stock to a 
group of investors, including certain officers, directors and affiliates, in 
order to partially fund the acquisition of GOLD BOND (Note 12). In addition, 
the Company issued to the seller of GOLD BOND, 155,792 shares of the 
Company's common stock at $6.42 per share.

STOCK OPTIONS

    Although the Company adopted SFAS No. 123, Accounting For Stock-Based 
Compensation, during 1997, it elected to continue to account for compensation 
expense under its stock option plans under APB No. 25. Accordingly, no 
compensation cost has been recognized for stock option grants since the 
options have exercise prices equal to the market value of the common stock at 
the date of grant.

                                     30

<PAGE>

    The Company's 1993 Non-Statutory Stock Option Plan (1993 Plan) provides 
for issuance of up to 350,000 shares of common stock to key employees. In 
addition, the Company's 1994 Non-Statutory Stock Option Plan and the 1994 
Non-Statutory Stock Option Plan for Non-Employee Directors (1994 Plans) 
provide for the issuance of up to 350,000 and 80,000 shares, respectively, of 
common stock. Options vest ratably over four years and are exercisable for a 
period of up to ten years from the date of grant.

    For SFAS No. 123 purposes, the fair value of each option grant has been 
estimated as of the date of grant using the Black-Scholes option-pricing 
model with the following weighted average assumptions for grants in 1997 and 
1996: expected dividend yield of 0%, expected volatility of 49%, risk-free 
interest rates of 6.48% and 5.39%, and expected lives of 6 years.

    Had compensation cost for 1997 and 1996 stock option grants been 
determined based on the fair value at the grant dates consistent with the 
method prescribed by SFAS No. 123, the Company's net income and net income 
per share would have been adjusted to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                        1997       1996
                                     ---------  ---------
<S>                                  <C>        <C>
Net income:
  As reported......................  $   5,885  $   3,272
  Pro forma........................  $   5,683  $   2,877
Net income per share:
  As reported......................  $    0.65  $    0.40
  Pro forma........................  $    0.62  $    0.35
</TABLE>

    The pro forma effect on net income in this disclosure is not 
representative of the pro forma effect on net income in future years because 
it does not take into consideration pro forma compensation expense related to 
grants made prior to 1996.

                                      31

<PAGE>

    A summary of the activity of stock options during 1997, 1996, and 1995 is 
presented below (shares in thousands):

<TABLE>
<CAPTION>
                                                                 1997                      1996                       1995
                                                         ---------------------     ---------------------     -------------------
<S>                                                      <C>          <C>          <C>          <C>          <C>        <C>
                                                                      WEIGHTED                  WEIGHTED                WEIGHTED
                                                          SHARES       AVERAGE      SHARES       AVERAGE     SHARES      AVERAGE
                                                          UNDER       EXERCISE      UNDER       EXERCISE     UNDER      EXERCISE
                                                          OPTION        PRICE       OPTION        PRICE      OPTION       PRICE
                                                         --------     --------     --------     --------     ------     --------
Outstanding at beginning of year.......................      613      $  6.39          646      $  7.60        675       $  7.69
  Granted..............................................       91         9.01          318         5.07         18          4.79
  Exercised............................................     (120)        6.65          (44)        6.93        --            -- 
  Cancelled............................................      --           --          (307)        7.48        (47)         7.83
                                                           -----        -----          ---        -----        ---         -----
Outstanding at end of year.............................      584      $  6.75          613      $  6.39        646       $  7.60
                                                           -----        -----          ---        -----        ---         -----
                                                           -----        -----          ---        -----        ---         -----
Options exercisable at year-end........................      262      $  7.43          221      $  7.73        305       $  7.72
                                                           -----        -----          ---        -----        ---         -----
                                                           -----        -----          ---        -----        ---         -----
Weighted average fair value of options granted.........               $  5.24                   $  2.62                     N/A
                                                                        -----                     -----                    -----
                                                                        -----                     -----                    -----

</TABLE>

    A summary of the exercise prices for options outstanding under the 
Company's stock-based compensation plans at November 30, 1997, is presented 
below (shares in thousands):

<TABLE>
<CAPTION>
                              WEIGHTED                                   WEIGHTED
                               AVERAGE     WEIGHTED                  AVERAGE EXERCISE
   EXERCISE     SHARES UNDER  EXERCISE     AVERAGE        SHARES     PRICE OF SHARES
 PRICE RANGE       OPTION      PRICE    REMAINING LIFE  EXERCISABLE    EXERCISABLE
------------    ------------  --------  --------------  -----------  ----------------
<S>             <C>           <C>       <C>             <C>          <C>
$4.63--$5.25        249       $  4.87         8.2            29          $ 4.85
$7.50--$9.50        330          7.99         6.5           233            7.76
   $18.00             5         18.00         9.8            --             N/A
                   ----       -------         ---           ---          ------
    Total           584       $  6.75         7.2           262          $ 7.43
                   ----       -------         ---           ---          ------
                   ----       -------         ---           ---          ------
</TABLE>

                                      32

<PAGE>

PREFERRED SHARES

    The Company is authorized to issue up to 1,000,000 preferred shares in 
series and with rights established by the board of directors. At November 30, 
1997 and 1996, no shares of any series of preferred stock were issued and 
outstanding.

EMPLOYEE STOCK OWNERSHIP PLAN

    Effective June 1, 1989, the Company established an Employee Stock 
Ownership Plan providing for the issuance of up to 360,000 shares of the 
Company's common stock. At November 30, 1997, no contributions had been made 
to the plan.

COMMON STOCK WARRANTS

    As described in Note 5, the Company issued the Warrants at an assigned 
value of $955. The Warrants are exercisable for five years. In the aggregate, 
75,000 warrants were issued which, when exercised, would entitle the holders 
thereof to acquire an aggregate of 417,182 shares of the Company's common 
stock. The number of shares of common stock and the price per share at which 
a warrant is exercisable are subject to adjustment upon the occurrence of 
certain events. A warrant does not entitle the holder to receive any cash 
dividends paid on common stock or to exercise any other rights as a 
shareholder of the Company.

    During 1996, as a result of the issuance of 1,100,000 shares of common 
stock (Note 9), the number of shares of common stock and the price per share 
at which a warrant is exercisable were adjusted from 5.56242 shares and 
$7.15, respectively, to 5.85733 shares and $6.79, respectively.

    During 1997, 12,030 warrants were exercised to acquire 70,464 shares. At 
November 30, 1997, 62,970 warrants were outstanding which, when exercised, 
would entitle the holders thereof to acquire an aggregate of 368,836 shares 
of the Company's common stock.


(10) CONTINGENCIES
-----------------------------------------------------------------------------

    Claims, suits and complaints arise in the ordinary course of the 
Company's business involving such matters as patents and trademarks, product 
liability and other alleged injuries or damage. The outcome of such 
litigation cannot be predicted, but, in the opinion of management, based in 
part upon the opinion of counsel, all such pending matters are without merit 
or are of such kind or involve such amounts as would not have a material 
adverse effect on the consolidated operating results or financial position of 
the Company if disposed of unfavorably.

                                       33

<PAGE>

(11) SUPPLEMENTAL FINANCIAL INFORMATION
-----------------------------------------------------------------------------

    A--Inventories consisted of the following at November 30, 1997 and 1996:

<TABLE>
<CAPTION>
                                                                                                1997       1996
                                                                                              ---------  ---------
<S>                                                                                           <C>        <C>
Raw materials and work in process...........................................................  $   9,107  $   5,365
Finished goods..............................................................................      7,850      7,484
Excess of current cost over LIFO value......................................................     (2,464)    (2,554)
                                                                                              ---------  ---------
  Total inventories.........................................................................  $  14,493  $  10,295
                                                                                              ---------  ---------
                                                                                              ---------  ---------
</TABLE>

    International inventories included above, valued on a lower of FIFO cost 
or market at November 30, 1997 and 1996, were $2,546 and $2,039, respectively.
 
    B--Property, plant and equipment consisted of the following at November 30,
1997 and 1996:

<TABLE>
<CAPTION>
                                                                                                 1997       1996
                                                                                               ---------  ---------
<S>                                                                                            <C>        <C>
Land.........................................................................................  $     138  $     208
Buildings and improvements...................................................................      3,150      3,014
Machinery and equipment......................................................................     23,416     21,973
Construction in progress.....................................................................      2,221      1,046
Less--accumulated depreciation...............................................................    (17,937)   (16,467)
                                                                                               ---------  ---------
  Property, plant and equipment, net.........................................................  $  10,988  $   9,774
                                                                                               ---------  ---------
                                                                                               ---------  ---------
</TABLE>

    C--Accrued liabilities consisted of the following at November 30, 1997 and
1996:

<TABLE>
<CAPTION>
                                                                                                1997       1996
                                                                                              ---------  ---------
<S>                                                                                           <C>        <C>
Accrued interest expense....................................................................  $   4,119  $   3,996
Salaries, wages and commissions.............................................................      1,696      1,287
Promotion expense...........................................................................      2,840      2,827
Product acquisitions........................................................................      1,489        614
Accrued pension benefits....................................................................        435      2,076
Other.......................................................................................      3,619      3,331
                                                                                              ---------  ---------
  Total accrued liabilities.................................................................  $  14,198  $  14,131
                                                                                              ---------  ---------
                                                                                              ---------  ---------
</TABLE>

                                       34

<PAGE>

(12) ACQUISITION AND SALE OF BRANDS
-----------------------------------------------------------------------------

    On June 26, 1997, the Company purchased certain assets of Sunsource 
International, Inc. and an affiliated company (SUNSOURCE) including the 
exclusive worldwide rights to five leading branded dietary supplement 
products. The purchase price for the trademarks, inventory and receivables 
was approximately $32,000, net of certain assumed liabilities. Additional 
payments may be earned by SUNSOURCE over a six year period from the date of 
closing if sales exceed certain levels as defined in the purchase agreement, 
but such additional payments are not to exceed $15,750 in the aggregate. 
Financing of the SUNSOURCE acquisition was provided by an expansion of the 
Company's senior bank credit agreement (Note 5) and the issuance of 300,000 
shares of Chattem, Inc. common stock to SUNSOURCE (Note 9).

    On April 29, 1996, the Company purchased the worldwide rights for the 
GOLD BOND line of medicated powders and anti-itch cream for approximately 
$40,000. The assets acquired consisted of the trademarks ($38,000) and 
inventory. Additionally, the Company assumed certain liabilities of 
approximately $500. The Company financed the GOLD BOND acquisition with bank 
borrowings (Note 5) and issuance of common stock (Note 9).

    On June 6, 1996, the Company purchased the rights for the HERPECIN-L line 
of medicated lip balm for $5,607 plus a royalty payment equal to the greater 
of $214 or 5% of net sales. The royalty payment is payable annually for each 
of the seven twelve-month periods beginning July 1, 1996 and ending June 30, 
2003. The assets acquired consisted primarily of the trademark ($5,159), 
receivables and inventory. Additionally, the Company assumed certain 
liabilities of approximately $500. The purchase was financed by the Company 
with additional bank borrowings of $5,000 with the remaining $607 being 
funded by the Company (Note 5).

    During April 1996, the Company sold the trademarks and inventory of two 
of its minor consumer products brands, SOLTICE and BLIS-TO-SOL, for $1,200 
consisting of $1,000 cash received at closing and a $200 promissory note 
requiring payments of $100 per year for the next two years contingent upon 
the brands meeting specific future sales levels.

    On June 17, 1994, the Company acquired a license to the PHISODERM 
trademark in the United States, Canada and Puerto Rico ("the Territory"), 
together with certain other assets from Sterling Winthrop Inc. (Sterling). If 
net sales of PHISODERM products in the United States exceed $11,000 for 
either of the 12-month periods beginning July 1, 1995 and July 1, 1996 and 
ending June 30, 1996 and June 30, 1997, then the Company will pay Sterling an 
additional $1,000 per year. Net sales of PHISODERM products exceeded $11,000 
for each of the 12-month periods ended June 30, 1997 and 1996. As a result, 
an additional $2,000 was recorded to patents, trademarks and other purchased 
product rights as of November 30, 1997.

                                       35

<PAGE>

(13) ACCRUED POSTRETIREMENT HEALTH CARE BENEFITS
-----------------------------------------------------------------------------

    The Company maintains certain postretirement health care benefits for 
eligible employees. Employees become eligible for these benefits if they meet 
certain age and service requirements. The Company pays a portion of the cost 
of medical benefits for certain retired employees over the age of 65. 
Effective January 1, 1993, the Company's contribution is a service-based 
percentage of the full premium. The Company pays these benefits as claims are 
incurred.

    Net periodic postretirement health care benefits cost for the years ended 
November 30, 1997, 1996 and 1995, included the following components:

<TABLE>
<CAPTION>
                                                                                              1997       1996       1995
                                                                                            ---------  ---------  ---------
<S>                                                                                         <C>        <C>        <C>
Service cost (benefits earned during the period)..........................................  $      29  $      36  $      30
Interest cost on accumulated postretirement benefits obligation...........................        115        101        102
Amortization of net loss..................................................................          2     --         --
                                                                                            ---------  ---------  ---------
Net periodic postretirement benefits cost.................................................  $     146  $     137  $     132
                                                                                            ---------  ---------  ---------
                                                                                            ---------  ---------  ---------
</TABLE>

    The following table sets forth the funded status of the plan, reconciled 
to the accrued postretirement health care benefits recognized in the 
Company's balance sheets at November 30, 1997 and 1996:

<TABLE>
<CAPTION>
                                                                                                   1997       1996
                                                                                                 ---------  ---------
<S>                                                                                              <C>        <C>
Accumulated postretirement benefits obligation:
  Retirees.....................................................................................  $     715  $     912
  Fully eligible active plan participants......................................................        502        275
  Other active participants....................................................................        377        260
Unrecognized net loss..........................................................................       (160)    --
                                                                                                 ---------  ---------
Accrued postretirement health care benefits....................................................  $   1,434  $   1,447
                                                                                                 ---------  ---------
                                                                                                 ---------  ---------
</TABLE>

    For measurement purposes, a 6.0% annual rate of increase in the per 
capita cost of covered health care benefits was assumed in 1997 and 1996. The 
weighted-average discount rate used in determining the accumulated 
postretirement benefit obligation was 7.5% at November 30, 1997 and 1996. A 
1% increase in the assumed health care cost trend rate would not affect the 
accumulated postretirement benefit obligation as of November 30, 1997 or the 
aggregate of the service and interest cost components of the net annual 
postretirement benefit cost for the year ended November 30, 1997.

                                       36

<PAGE>

(14) DISCONTINUED OPERATIONS
-----------------------------------------------------------------------------

    On May 26, 1995, the Company completed the sale of its specialty 
chemicals division to privately-held Elcat. The Company received $25,000 from 
the sale of the specialty chemicals division consisting of $20,000 in cash 
and $5,000 of 13.125% cumulative, convertible preferred stock of Elcat. The 
net cash proceeds were used to repay long-term debt of approximately $12,000. 
The Company recognized a gain of $9,334, (after tax) from the sale and 
extraordinary charge (after tax) of $367 relating to the early extinguishment 
of the debt.

    The results of operations and the gain on disposal of the specialty 
chemicals division have been separately classified as discontinued operations 
in the accompanying consolidated statements of income. Net sales of the 
specialty chemicals division were $6,739 through May 26, 1995. Interest 
expense of $351 for 1995 was allocated to discontinued operations based upon 
the ratio of net assets discontinued to the total net assets of the 
consolidated entity.


15) SUBSEQUENT EVENT

    On February 22, 1998, the Company entered into a definitive agreement to 
acquire the BAN anti-perspirant and deodorant brand from Bristol-Myers Squibb 
Company. Pursuant to the terms of the acquisition agreement, the Company will 
purchase all the assets, including, inventories, patents and trademarks of 
BAN (excluding the rights in Japan), for $165 million in cash, plus assumed 
liabilities. The purchase price will be funded by debt financing. This 
acquisition transaction is expected to close no later than March 31, 1998.

                                       37

<PAGE>

                            REPORT OF INDEPENDENT

                             PUBLIC ACCOUNTANTS
 
To the Shareholders and Board of Directors of Chattem, Inc.:
 
    We have audited the accompanying consolidated balance sheets of Chattem, 
Inc. (a Tennessee corporation) and subsidiaries as of November 30, 1997 and 
1996 and the related consolidated statements of income, shareholders' equity 
(deficit) and cash flows for each of the three years in the period ended 
November 30, 1997. These financial statements are the responsibility of the 
Company's management. Our responsibility is to express an opinion on these 
financial statements based on our audits.
 
    We conducted our audits in accordance with generally accepted auditing 
standards. Those standards require that we plan and perform the audit to 
obtain reasonable assurance about whether the financial statements are free 
of material misstatement. An audit includes examining, on a test basis, 
evidence supporting the amounts and disclosures in the financial statements. 
An audit also includes assessing the accounting principles used and 
significant estimates made by management, as well as evaluating the overall 
financial statement presentation. We believe that our audits provide a 
reasonable basis for our opinion.
 
    In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Chattem, Inc. and
subsidiaries as of November 30, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
November 30, 1997 in conformity with generally accepted accounting principles.


 
ARTHUR ANDERSEN LLP


Chattanooga, Tennessee 
January 19, 1998
(except with respect to the
matter discussed in Note 15
as to which the date is
February 23, 1998)


                                   38

<PAGE>

                             Quarterly Information 
                (Unaudited and in thousands, except per share amounts)
 

<TABLE>
<CAPTION>
                                                                                         QUARTER ENDED
                                                                                     ----------------------
                                                              TOTAL     FEBRUARY 28   MAY 31     AUGUST 31    NOVEMBER 30
                                                            ----------  -----------  ---------  -----------  -------------
<S>                                                         <C>         <C>          <C>        <C>          <C>
FISCAL 1997:
  Continuing operations:
    Net sales............................................  $  143,235      27,946      39,178      38,909        37,202
    Gross profit.........................................  $  103,982      19,552      28,290      28,809        27,331
    Income (1)...........................................  $    7,255         136       3,057       2,847         1,215
    Income per share (1).................................  $      .80         .02         .35         .31           .13
  Total:
    Net income...........................................  $    5,885         136       3,057       1,477         1,215
    Net income per share(2)..............................  $      .65         .02         .35         .16           .13
FISCAL 1996:
  Continuing operations:
    Net sales............................................  $  118,903      18,697      30,430      38,841        30,935
    Gross profit.........................................  $   83,783      12,948      21,101      27,453        22,281
    Income (loss) (1)....................................  $    3,804         (38)      2,010       2,131          (299)
    Income (loss) per share (1)..........................  $      .47        (.01)        .26         .24          (.02)
  Total:
    Net income (loss)....................................  $    3,272         (38)      1,478       2,131          (299)
    Net income (loss) per share(2).......................  $      .40        (.01)        .19         .24          (.02)
</TABLE>
 
------------------------
 
(1) Before extraordinary loss on early extinguishment of debt.
 
(2) The sum of the quarterly earnings per share amounts may differ from annual
    earnings per share because of the differences in the weighted average number
    of common shares and common share equivalents used (where dilutive) in the
    quarterly and annual computations.
 


                                        39

<PAGE>

                                       Geographical Segment Information
                                                (In thousands)
 
<TABLE>
<CAPTION>
                                                                                      YEAR ENDED NOVEMBER 30,
                                                                                 ----------------------------------
                                                                                    1997        1996        1995
                                                                                 ----------  ----------  ----------
<S>                                                                              <C>         <C>         <C>
NET SALES:
  Domestic.....................................................................  $  128,024  $  104,444  $   87,250
  International................................................................      15,211      14,459      13,348
                                                                                 ----------  ----------  ----------
    Consolidated...............................................................  $  143,235  $  118,903  $  100,598
                                                                                 ----------  ----------  ----------
                                                                                 ----------  ----------  ----------
OPERATING INCOME:
  Domestic.....................................................................  $   27,393  $   18,929  $   16,719
  International................................................................       1,710       1,613       1,292
                                                                                 ----------  ----------  ----------
    Total......................................................................      29,103      20,542      18,011
  Other unallocated expenses, net (1)..........................................     (17,855)    (14,922)    (14,401)
                                                                                 ----------  ----------  ----------
    Income from continuing operations before income taxes......................  $   11,248  $    5,620  $    3,610
                                                                                 ----------  ----------  ----------
                                                                                 ----------  ----------  ----------
IDENTIFIABLE ASSETS:
  Domestic.....................................................................  $  164,175  $  135,238  $   69,732
  International................................................................       7,929      10,961       8,350
                                                                                 ----------  ----------  ----------
    Total......................................................................     172,104     146,199      78,082
  Investment in Elcat, Inc.....................................................       6,640       5,984       5,328
                                                                                 ----------  ----------  ----------
    Consolidated...............................................................  $  178,744  $  152,183  $   83,410
                                                                                 ----------  ----------  ----------
                                                                                 ----------  ----------  ----------
</TABLE>
 
------------------------
 
(1) Principally interest expense and corporate overhead not allocated.
 
                                       40
<PAGE>

<TABLE>
<S>                                    <C>                             <C>
Board of Directors                     Officers                        Chattem, Inc.
                                                                       1715 West 38th Street
ZAN GUERRY                             ZAN GUERRY                      Chattanooga, TN 37409
Chairman and Chief Executive           Chairman and Chief              Corporate Office
  Officer                                Executive Officer
Chattem, Inc.
Chattanooga, TN                        A. ALEXANDER TAYLOR II          Subsidiaries and Affiliated Companies
                                       President and Chief Operating                                           
A. ALEXANDER TAYLOR II                   Officer                       CHATTEM (U.K.) LIMITED                  
President and Chief Operating                                          Guerry House                            
  Officer                              HUGH F. SHARBER                 Ringway Centre                          
Chattem,  Inc.,                        Secretary                       Edison Road                             
Chattanooga, TN                                                        Basingstoke, Hampshire RG21 2YH         
                                       ADDITIONAL                      England                                 
SAMUEL E. ALLEN                        FINANCIAL                                                               
Chairman                               INFORMATION                     CHATTEM (CANADA) INC.                   
GLOBALT, Inc.                          Copies of quarterly press       2220 Argentia Road                      
Atlanta, GA                            releases and/or quarterly       Mississauga, Ontario L5N 2K7            
                                       reports on Form 10-Q and                                                
LOUIS H. BARNETT                       annual report on Form 10-K,     HBA INSURANCE LTD.                      
Business Consultant                    both forms filed with the       P.O. Box HM 2062                        
Fort Worth, TX                         Securities and Exchange         Hamilton 5, Bermuda                     
                                       Commission, may be obtained                                             
ROBERT E. BOSWORTH                     without charge by writing to    SIGNAL INVESTMENT &                     
Business Consultant                    the Controller, Chattem, Inc.   MANAGEMENT CO.                          
Chattanooga, TN                        or by calling-                  1105 North Market Street                
                                       1-800-366-6077, Ext. 769.       Suite 1300                              
RICHARD  E. CHENEY                                                     Wilmington, DE 19890                    
Former Chairman Emeritus                                                                                       
Hill and Knowlton, Inc.                                                COMMON STOCK LISTING                    
New York, NY                                                           Over-the-Counter                        
                                                                       NASDAQ Symbol: CHTT                     
SCOTT L. PROBASCO, JR.                                                                                         
Chairman of the Executive                                              TRANSFER AGENT AND                      
  Committee                                                            REGISTRAR                               
SunTrust Bank, Tennessee, N.A.                                         SunTrust Bank, Atlanta, N.A.            
Chattanooga, TN                                                        P.O. Box 4625                           
                                                                       Atlanta, GA  30302                      

                                       
                                       
                                       
                                       
                                                        

</TABLE>